UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2018

 

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: 001-37685

 

 

PAVMED INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Delaware 47-1214177
(State or Other Jurisdiction of
Incorporation or Organization)
(IRS Employer
Identification No.)

 

One Grand Central Place
Suite 4600
New York, NY
(Address of Principal Executive Offices)
10165
(Zip Code)

 

(212) 949-4319
(Registrant’s Telephone Number, Including Area Code)

 

 

Securities registered under Section 12(b) of the Exchange Act:

 

  Title of each class Name of each exchange on which registered
  Common Stock, $0.001 par value per share The NASDAQ Stock Market LLC
  Series Z Warrants, each to purchase one share of Common Stock The NASDAQ Stock Market LLC
  Series W Warrants, each to purchase one share of Common Stock The NASDAQ Stock Market LLC

 

Securities registered under Section 12(g) of the Exchange Act: None

 

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 [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting 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.

 

Large accelerated filer [  ]     Accelerated filer [  ]
Non-accelerated filer [  ]  (Do not check if a smaller reporting company)   Smaller reporting company [X]
        Emerging growth company [X]

 

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 [X]

 

As of May 18, 2018 there were 17,509,654 shares of the registrant’s Common Stock, par value $0.001 per share, outstanding.

 

 

 

 
 

 

TABLE OF CONTENTS

 

    Page
PART I FINANCIAL INFORMATION
     
Item 1 Unaudited Condensed Consolidated Financial Statements 1
     
  Unaudited Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017 1
     
  Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2018 and 2017 2
     
  Unaudited Condensed Consolidated Statements of Changes in Series A Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the three months ended March 31, 2018 3
     
  Unaudited Condensed Consolidated Statements of Changes in Series A Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the year ended December 31, 2017 4
     
  Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017 5
     
  Notes to Unaudited Condensed Consolidated Financial Statements 6
     
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations 49
     
Item 3 Quantitative and Qualitative Disclosures About Market Risk 79
     
Item 4 Controls and Procedures 79
     
PART II OTHER INFORMATION  
     
Item 2 Unregistered Sale of Equity Securities 80
     
Item 6 Exhibits 80
     
SIGNATURES 81

 

i
 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

PAVMED INC.

and SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

 

   March 31, 2018   December 31, 2017 
Assets          
Current assets          
Cash  $3,630,692   $1,535,022 
Prepaid expenses and other current assets   113,833    88,467 
Total current assets   3,744,525    1,623,489 
Equipment, net   14,388    16,191 
Total assets  $3,758,913   $1,639,680 
           
Liabilities, Preferred Stock, and Stockholders’ Deficit          
Current liabilities          
Accounts payable  $767,606   $864,405 
Accrued expenses and other current liabilities   298,900    706,024 
Accrued interest expense   194,570     
Series A Warrants derivative liability       761,123 
Series A Convertible Preferred Stock conversion option derivative liability       212,217 
Total current liabilities   1,261,076    2,543,769 
           
Senior Secured Note, net of $2,938,541 and $3,244,274 unamortized debt discount as of March 31, 2018 and December 31, 2017, respectively   2,250,001    1,944,268 
           
Total liabilities  $3,511,077   $4,488,037 
           
COMMITMENTS AND CONTINGENCIES (NOTE 9)          
           
Series A Convertible Preferred Stock          
Preferred stock, par value $0.001, 20,000,000 shares authorized;          
Series A Convertible Preferred Stock, par value $0.001, 0 and 249,667 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively        
           
Stockholders’ Equity (Deficit)          
Preferred stock, par value $0.001, 20,000,000 shares authorized;          
           
Series B Convertible Preferred Stock, par value $0.001, 975,568 and 0 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively   1,707,244     
           
Series A-1 Convertible Preferred Stock, par value $0.001, 0 and 357,259 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively       1,032,650 
           
Common stock, par value $0.001; 50,000,000 shares authorized, 17,509,654 and 14,551,234 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively   17,509    14,551 
           
Additional paid-in capital   19,982,594    14,012,053 
           
Accumulated deficit   (21,459,511)   (17,907,611)
Total Stockholders’ Equity (Deficit)   247,836    (2,848,357)
           
Total Liabilities, Series A Convertible Preferred Stock, and Stockholders’ Equity (Deficit)  $3,758,913   $1,639,680 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

1
 

 

PAVMED INC.

and SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

   Three Months Ended 
   March 31, 2018   2017 
Revenue  $   $ 
           
General and administrative expenses   1,381,167    1,499,552 
Research and development expenses   562,535    656,713 
Total operating expenses   1,943,702    2,156,265 
           
Loss from operations   (1,943,702)   (2,156,265)
           
Other income (expense)          
Interest expense   (500,304)    
Excess of fair value of Series Z Warrants issued in connection with the Series A and Series A-1 Exchange Offer   (349,796)    
Loss on issuance of Series A Preferred Stock Units in a private placement       (3,124,285)
Change in fair value of Series A Warrants derivative liability   (96,480)   786,397 
Change in fair value of Series A Convertible Preferred Stock conversion option derivative liability   64,913    224,065 
Other income (expense), net   (881,667)   2,113,823 
           
Loss before income tax   (2,825,369)   (4,270,088)
           
Provision for income taxes        
           
Net loss   (2,825,369)   (4,270,088)
           
Series A Convertible Preferred Stock dividends   (26,487)   (26,440)
Series A-1 Convertible Preferred Stock dividends   (25,148)    
Series B Convertible Preferred Stock dividends   (10,406)    
           
Deemed dividend - Series B Convertible Preferred Stock issued upon exchange of Series A Convertible Preferred Stock in the Series A and Series A-1 Exchange Offer   (726,531)    
           
Series B Convertible Preferred Stock issued upon the exchange of Series A-1 Convertible Preferred Stock in the Series A and Series A-1 Exchange Offer   199,241     
           
Net loss attributable to common stockholders  $(3,414,700)  $(4,296,528)
           
Net loss per share - basic and diluted  $(0.17)  $(0.32)
           
Net loss attributable to common stockholders per share - basic and diluted  $(0.21)  $(0.32)
           
Weighted average common shares outstanding - basic and diluted   16,544,221    13,330,891 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

2
 

 

PAVMED INC.

and SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

SERIES A CONVERTIBLE PREFERRED STOCK AND

STOCKHOLDERS’ EQUITY (DEFICIT)

(unaudited)

 

       Stockholders’ Equity (Deficit) 
   Series A   Series B   Series A-1                   Total 
   Convertible   Convertible   Convertible           Additional       Stockholders’ 
   Preferred Stock   Preferred Stock   Preferred Stock   Common Stock   Paid-In   Accumulated   Equity 
   Shares   Amount   Shares   Amount   Shares   Amount   Shares   Amount   Capital   Deficit   (Deficit) 
                                             
Balance at December 31, 2017   249,667   $---    ---   $---    357,259   $1,032,650    14,551,234   $14,551   $14,012,053   $(17,907,611)  $(2,848,357)
                                                        
Common stock issued in an underwritten public offering, net of offering cost                                 2,649,818    2,650    4,272,011         4,274,661 
                                                        
Series A and Series A-1 Exchange Offer   (249,667)   ---    975,568    1,707,244    (357,259)   (1,032,650)             1,406,640    (726,531)   1,354,703 
                                                        
Common stock issued upon exercise of warrants, net of offering costs                                 308,602    308    20,604         20,912 
                                                        
Stock-based compensation                                           271,286         271,286 
                                                        
Net loss                                                (2,825,369)   (2,825,369)
                                                        
Balance at March 31, 2018   ---   $---    975,568   $1,707,244    ---   $---    17,509,654   $17,509   $19,982,594   $(21,459,511)  $247,836 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

3
 

 

PAVMED INC.

and SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

SERIES A CONVERTIBLE PREFERRED STOCK AND

STOCKHOLDERS’ EQUITY (DEFICIT)

(unaudited)

 

       Stockholders’ Equity (Deficit) 
   Series A   Series A-1                     
   Convertible   Convertible           Additional       Total 
   Preferred Stock   Preferred Stock   Common Stock   Paid-In   Accumulated   Stockholders 
   Shares   Amount   Shares   Amount   Shares   Amount   Capital   Deficit   Equity (Deficit) 
                                     
Balance at December 31, 2016      $       $    13,330,811   $13,331   $7,369,437   $(7,701,835)  $(319,067)
                                              
Series A Convertible Preferred  Stock issued in a  in a private placement   422,838                                       
                                              
Series A-1 Convertible Preferred  Stock and Series A-1 Warrants  issued in a private placement             125,000    7,050              492,950         500,000 
                                              
Series A Exchange Offer   (154,837)       232,259    843,100              1,347,082    (504,007)   1,686,175 
                                              
Series A-1 Convertible Preferred  Stock deemed dividend                  182,500                   (182,500)    
                                              
Modification of Series A-1  Warrant Agreement                                 222,000         222,000 
                                              
Series S Warrants issued in  connection with Senior Secured  Note payable                                 3.434,452         3,434,452 
                                              
Common stock issued upon  exercise of warrants                       1,193,330    1,198    70,692         71,890 
                                              
Common stock issued upon  conversion of Series A  Convertible Preferred Stock   (18,334)                 22,093    22    27,313         27,335 
                                              
Stock-based compensation                                 1,048,127         1,048,127 
                                              
Net loss                                      (9,519,269)   (9,519,269)
                                              
Balance at December 31, 2017   249,667   $    357,259   $1,032,650    14,551,234   $14,551   $14,012,053   $(17,907,611)  $(2,848,357)

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

4
 

 

PAVMED INC.

and SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   Three Months Ended March 31, 
   2018   2017 
Cash flows from operating activities          
Net loss  $(2,825,369)  $(4,270,088)
Adjustments to reconcile net loss to net cash used in operating activities          
Depreciation expense   1,803    1,702 
Stock-based compensation   271,286    272,680 
Loss on issuance of Preferred Stock Units       3,124,285 
Change in fair value - Series A Warrants derivative liability   96,480    (786,397)
Change in fair value - Series A Convertible Preferred Stock conversion option derivative liability   (64,913)   (224,065)
Excess of fair value of Series Z Warrants issued upon the exchange of          
Series A-1 Warrants in the Series A and Series A-1 Exchange Offer   349,796     
Accrued interest expense - Senior Secured Note   194,570     
Amortization of discount - Senior Secured Note   305,733     
Changes in operating assets and liabilities:          
Prepaid fee to related party       (25,000)
Prepaid expenses and other current assets   (25,366)   13,647 
Accounts payable   (96,799)   (15,205)
Accrued expenses and other current liabilities   (407,124)   83,334 
Net cash flows used in operating activities   (2,199,903)   (1,825,107)
           
Cash flows from investing activities          
Purchase of equipment       (5,301)
Net cash flows used in investing activities       (5,301)
           
Cash flows from financing activities          
Proceeds from issue of common stock in an underwritten public offering   4,388,099     
Payment of offering costs - underwritten public offering   (113,438)    
Proceeds from issue of Series A Preferred Stock Units private placement       2,537,012 
Payment of offering costs - Series A Preferred Stock Units private placement       (388,628)
Proceeds from common stock issued upon exercise of warrants, net   20,912    2,000 
Net cash flows provided by financing activities   4,295,573    2,150,384 
           
Net increase (decrease) in cash  $2,095,670   $319,976 
Cash, beginning of period   1,535,022    585,680 
Cash, end of period  $3,630,692   $905,656 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

5
 

 

PAVMED INC. AND SUBSIDIARY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 — The Company, Description of the Business, and Going Concern

 

PAVmed Inc. (“PAVmed” or the “Company”) is a highly-differentiated multi-product medical device company organized to advance a broad pipeline of innovative medical technologies from concept to commercialization, employing a business model focused on capital efficiency and speed to market. The Company is focused on advancing its lead products towards regulatory approval and commercialization, protecting its intellectual property, and building its corporate infrastructure and management team. The Company was organized under the laws of the State of Delaware on June 26, 2014 (inception), originally under the name of PAXmed Inc., and on April 19, 2015, changed its name to PAVmed Inc. The Company operates in one segment as a medical device company.

 

The Company has financed its operations principally through the issuances of its common stock, preferred stock, warrants, and debt. Prior to the Company’s 2016 initial public offering (IPO), the Company raised approximately $2.1 million of net cash proceeds from private offerings of its common stock and warrants. See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants, for a discussion of the Company’s common stock and warrants issued prior to the Company’s IPO.

 

Under a registration statement on Form S-1 (File No. 333-203569) declared effective January 29, 2016, the Company’s IPO was consummated on April 28, 2016, resulting in approximately $4.2 million of net cash proceeds, after deducting cash selling agent discounts and commissions and offering expenses, from the issuance of 1,060,000 units at an offering price of $5.00 per unit, with each such unit comprised of one share of common stock of the Company and one warrant to purchase a share of common stock of the Company, with such warrant referred to as a “Series W Warrant”. See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants, for a further discussion of the Company’s common stock and Series W Warrants.

 

In January 2018, the Company raised $4.3 million of net cash proceeds in an underwritten public offering of shares of common stock of the Company pursuant to its previously filed effective shelf registration statement on United States Securities and Exchange Commission (“SEC”) Form S-3 (File No. 333-220549). See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrant, for a further discussion of the January 2018 underwritten public offering of shares of common stock of the Company.

 

In the year ended December 31, 2017, the Company raised approximately $7.5 million of net cash proceeds, including: the Note and Security Purchase Agreement with Scopia Holdings LLC, the Series A-1 Preferred Stock Units private placement; and the Series A Preferred Stock Units private placement.

 

See Note 12, Note and Securities Purchase Agreement, Senior Secured Note, and Series S Warrants, for a further discussion of the Note and Security Purchase Agreement with Scopia Holdings LLC; and, Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants, for a further discussion of the Series A-1 Preferred Stock Units private placement, Series A Preferred Stock Units private placement, and the issue of common stock of the Company in an underwritten public offering in January 2018.

 

Nasdaq Notice

 

On March 5, 2018, the Company received a notice from the Nasdaq Listing Qualifications Department stating, for the prior 30 consecutive business days through March 2, 2018, the market value of the Company’s listed securities (“MVLS”) had been below the minimum of $35 million required for continued inclusion on the Nasdaq Capital Market under Nasdaq Listing Rule 5550(b)(2). The notification letter stated the Company would be afforded 180 calendar days, or until September 4, 2018, to regain compliance. In order to regain compliance, the MVLS must remain at or above $35 million for a minimum of ten consecutive business days. The notification letter also states in the event the Company does not regain compliance within the 180 day period, its securities may be subject to delisting. In the event of a delisting determination, the Company may appeal such determination to a Nasdaq Hearings Panel.

 

6
 

 

Note 1 — The Company, Description of the Business, and Going Concern (continued)

 

Going Concern

 

The provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 205-40, Presentation of Financial Statements - Going Concern (ASC 205-40) requires management to assess an entity’s ability to continue as a going concern within one year of the date of the financial statements are issued. In each reporting period, including interim periods, an entity is required to assess conditions known and reasonably knowable as of the financial statement issuance date to determine whether it is probable an entity will not meet its financial obligations within one year from the financial statement issuance date. Substantial doubt about an entity’s ability to continue as a going concern exists when conditions and events, considered in the aggregate, indicate it is probable the entity will be unable to meet its financial obligations as they become due within one year after the date the financial statements are issued.

 

The Company is an early stage and emerging growth company and has not generated any revenues to date. As such, the Company is subject to all of the risks associated with early stage and emerging growth companies. Since inception, the Company has incurred losses and negative cash flows from operating activities. The Company does not expect to generate positive cash flows from operating activities in the near future until such time, if at all, it completes the development process of its products, including regulatory approvals and clearances, and thereafter, begins to commercialize and achieve substantial marketplace acceptance for the first of a series of products in its medical device portfolio, which is not expected to occur in the near future, if at all.

 

The Company incurred a net loss attributable to common stockholders of $3,414,700 and had net cash flows used in operating activities of $2,199,903 for the three months ended March 31, 2018. As of March 31, 2018, the Company had an accumulated deficit of $21,459,511 and working capital of $2,483,449.

 

The Company anticipates incurring operating losses and does not expect to experience positive cash flows from operating activities, and may continue to incur operating losses for the next several years as it completes the development of its products, seeks regulatory approvals and clearances of such products, and begins to commercially market such products. These factors, which have existed since inception, are expected to continue for the foreseeable future, and raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the accompanying unaudited condensed consolidated financial statements are issued.

 

The Company’s ability to fund its operations is dependent upon management’s plans, which include raising additional capital, obtaining regulatory approvals for its products currently under development, commercializing and generating revenues from products currently under development, and continuing to control expenses. However, there is no assurance the Company will be successful in these efforts.

 

A failure to raise sufficient capital, obtain regulatory approvals and clearances for the Company’s products, generate sufficient product revenues, or control expenditures, among other factors, will adversely impact the Company’s ability to meet its financial obligations as they become due and payable and to achieve its intended business objectives, and therefore, raises substantial doubt of the Company’s ability to continue as a going concern within one year after the date the unaudited condensed consolidated financial statements are issued.

 

The Company’s unaudited condensed consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. The unaudited condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities should the Company be unable to continue as a going concern.

 

7
 

 

Note 2 — Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation. The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and applicable rules and regulations of the SEC regarding interim financial reporting. As permitted under SEC rules, certain footnotes or other financial information normally required by U.S. GAAP have been condensed or omitted, and accordingly the balance sheet as of December 31, 2017 has been derived from audited consolidated financial statements at such date but does not include all of the information required by U.S. GAAP for complete financial statements. These unaudited condensed consolidated financial statements have been prepared on the same basis as the Company’s annual financial statements and in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial information. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or for any other interim period or for any other future periods. The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and related notes thereto as of and for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make accounting 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 expenses during the reporting period. Significant estimates in these unaudited condensed consolidated financial statements include those related to the fair value of warrants, the fair value of derivative liabilities, stock-based compensation, research and development expenses, the provision or benefit for income taxes and the corresponding valuation allowance on deferred tax assets. In addition, management’s assessment of the Company’s ability to continue as a going concern involves the estimation of the amount and timing of future cash inflows and outflows. On an ongoing basis, the Company evaluates its estimates, judgements, and methodologies. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable. Due to the inherent uncertainty involved in making such accounting estimates and assumptions, the actual financial statement results could differ materially from such accounting estimates and assumptions.

 

Cash

 

The Company maintains its cash at a major financial institution with high credit quality. At times, the balance of its cash deposits may exceed federally insured limits. The Company has not experienced and does not anticipate any losses on deposits with commercial banks and financial institutions which exceed federally insured limits.

 

Equipment

 

Equipment is stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Maintenance and repairs are charged to operations as incurred. Upon sale or retirement of assets, the cost and related accumulated depreciation are removed from the balance sheet and resulting gain or loss, if any, is included in the unaudited condensed consolidated statement of operations. The useful lives of equipment are as follows:

 

Research and development equipment 5 years
Computer equipment 3 years

 

Long-Lived Assets

 

The Company evaluates its long-lived assets, including equipment, for impairment whenever events or changes in circumstances indicate the carrying value of these assets may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the asset is considered impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired assets. The Company has not recorded impairment of any long-lived assets in the periods presented.

 

Research and Development Expenses

 

Research and development expenses are recognized as incurred and include the salary and stock-based compensation of employees engaged in product research and development activities, and the costs related to the Company’s various contract research service providers, suppliers, engineering studies, supplies, and outsourced testing and consulting, as well as rental costs for equipment and access to certain facilities of contract research service providers.

 

8
 

 

Note 2 — Summary of Significant Accounting Policies (continued)

 

Patent Costs and Purchased Patent License Rights

 

Patent related costs in connection with filing and prosecuting patent applications and patents filed by the Company are expensed as incurred, and are included in the line item captioned “general and administrative expenses” in the accompanying unaudited condensed consolidated statements of operations. Patent fee reimbursement expense incurred under the Tufts Patent License Agreement for antimicrobial resorbable ear tubes, are included in the line item captioned “research and development expenses” in the accompanying unaudited condensed consolidated statements of operations. The purchase of patent license rights for use in research and development activities are expensed as incurred and are classified as research and development expense.

 

Offering Costs

 

Offering costs consist of certain legal, accounting, and other advisory fees incurred related to the Company’s efforts to raise debt and equity capital. Offering costs in connection with equity financing are recognized as either an offset against the financing proceeds to extent the underlying security is equity classified or a current period expense to extent the underlying security is liability classified. Offering costs, lender fees, and warrants issued in connection with debt financing are recognized as debt discount, which reduces the reported carrying value of the debt, and amortized as interest expense, generally over the contractual term of the debt agreement, to result in a constant rate of interest. Offering costs associated with in-process capital financing are accounted for as deferred offering costs.

 

Financial Instruments Fair Value Measurements

 

The Company evaluates its financial instruments to determine if those instruments or any embedded components of those instruments potentially qualify as derivatives that need to be separately accounted for in accordance with FASB ASC Topic 815, Derivatives and Hedging (ASC 815). The accounting for warrants issued to purchase shares of common stock of the Company is based on the specific terms of the respective warrant agreement, and are generally classified as equity, but may be classified as a derivative liability if the warrant agreement provides required or potential full or partial cash settlement. A warrant classified as a derivative liability, or a bifurcated embedded conversion or settlement option classified as a derivative liability, is initially measured at its issue-date fair value, with such fair value subsequently adjusted at each reporting period, with the resulting fair value adjustment recognized as other income or expense. If upon the occurrence of an event resulting in the derivate liability being subsequently classified as equity or otherwise derecognized, the fair value of the derivative liability will be adjusted on such date-of-occurrence, with such date-of-occurrence fair value adjustment recognized as other income or expense, and then the derivative liability will be derecognized at such date-of-occurrence fair value.

 

FASB ASC Topic 820, Fair Value Measurement, (ASC 820) defines fair value as the price which would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at a transaction measurement date. The ASC 820 three-tier fair value hierarchy prioritizes the inputs used in the valuation methodologies, as follows:

 

  Level 1 Valuations based on quoted prices for identical assets and liabilities in active markets.
     
  Level 2 Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets which are not active, or other inputs observable or can be corroborated by observable market data.
     
  Level 3 Valuations based on unobservable inputs reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

 

As of March 31, 2018 and December 31, 2017, the carrying values of cash, accounts payable, and accrued expenses, approximate their respective fair value due to the short-term nature of these financial instruments.

 

The Company evaluates its financial instruments to determine if those instruments or any potential embedded components of those instruments qualify as derivatives that need to be separately accounted for in accordance with FASB ASC Topic 815, Derivatives and Hedging (ASC 815). Warrants are classified as either equity or a derivative liability depending on the specific terms of the respective warrant agreement. The Series A Warrants are accounted for as a derivative liability, as such warrants have an exercise price adjustment provision. Warrants containing a cash settlement provision are accounted for as a derivative liability. A warrant classified as a liability, or a bifurcated embedded derivative classified as a liability, is initially measured at its issue-date fair value, with such fair value subsequently adjusted at each reporting period, with the resulting adjustment recognized as other income or expense. If upon the occurrence of an event resulting in the warrant liability or the embedded derivative liability being subsequently classified as equity, the fair value will be adjusted on such date-of-occurrence, with such date-of-occurrence fair value adjustment recognized as other income or expense, and then it will be classified as equity at such date-of-occurrence adjusted fair value.

 

9
 

 

Note 2 — Summary of Significant Accounting Policies (continued)

 

Stock-Based Compensation

 

The Company issues stock-based awards to employees, members of its board of directors, and non-employees. Stock-based awards to employees and members of its board of directors are accounted for in accordance with FASB ASC Topic 718, Stock Compensation, and stock-based awards to non-employees are accounted for in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees.

 

The Company measures the compensation expense of stock-based awards granted to employees and members of its board of directors using the grant-date fair value of the award and recognizes compensation expense for stock-based awards on a straight-line basis over the requisite service period, which is generally the vesting period of the respective stock-based award.

 

The Company measures the expense of stock-based awards granted to non-employees on a vesting date basis, fixing the fair value of vested non-employee stock options as of their respective vesting date. The fair value of vested non-employee stock options is not subject-to-change at subsequent reporting dates. The estimated fair value of the unvested non-employee stock options is remeasured to then current fair value at each subsequent reporting date. The expense of non-employee stock options is recognized on a straight-line basis over the service period, which is generally the vesting period of the respective non-employee stock-based award.

 

In March 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, (“ASU 2016-09”) which simplified several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for the Company beginning January 1, 2017, although early adoption is permitted. The Company elected to early adopt ASU 2016-09 effective as of April 1, 2016. As the Company did not have any stock options issued or outstanding prior to the closing of its IPO, the early adoption did not have an impact on the Company’s unaudited condensed consolidated financial position, results of operations and cash flows.

 

Income Taxes

 

The Company accounts for income taxes using the asset and liability method, as required by FASB ASC Topic 740, Income Taxes, (ASC 740). Current tax liabilities or receivables are recognized for the amount of taxes estimated to be payable or refundable for the current year. Deferred tax assets and liabilities are recognized for estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, along with net 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. See Note 7, Income Taxes, for a discussion of the “Tax Cuts and Jobs Act of 2017”, enacted on December 22, 2017, which resulted in a change to future years’ statutory federal corporate tax rate applicable to taxable income. Changes in deferred tax assets and liabilities are recorded in the provision for income taxes.

 

Under ASC 740, a “more-likely-than-not” criterion is applied when assessing the estimated realization of deferred tax assets through their utilization to reduce future taxable income, or with respect to a deferred tax asset for tax credit carryforward, to reduce future tax expense. A valuation allowance is established, when necessary, to reduce deferred tax assets, net of deferred tax liabilities, when the assessment indicates it is more-likely-than-not, the full or partial amount of the net deferred tax asset will not be realized. As a result of the evaluation of the positive and negative evidence bearing upon the estimated realizability of net deferred tax assets, and based on a history of operating losses, it is more-likely-than-not the deferred tax assets will not be realized, and therefore a valuation allowance reserve equal to the full amount of the deferred tax assets, net of deferred tax liabilities, has been recognized as a charge to income tax expense as of March 31, 2018 and December 31, 2017.

 

The Company recognizes the benefit of an uncertain tax position it has taken or expects to take on its income tax return if such a position is more-likely-than-not to be sustained upon examination by the taxing authorities, with the tax benefit recognized being the largest amount having a greater than 50% likelihood of being realized upon ultimate settlement. As of March 31, 2018 the Company does not have any unrecognized tax benefits resulting from uncertain tax positions.

 

The Company’s policy is to record interest and penalties related to income taxes as part of its income tax provision. There were no amounts accrued for penalties or interest as of March 31, 2018 and December 31, 2017, or recognized during the three months ended March 31, 2018 and 2017. The Company is not aware of any issues under review to potentially result in significant payments, accruals, or material deviations from its position.

 

10
 

 

Note 2 — Summary of Significant Accounting Policies (continued)

 

Net Loss Per Share

 

Basic net loss per share and basic net loss attributable to common stockholders per share, are each computed by dividing the net loss and the net loss attributable to common stockholders, respectively, by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share and diluted net loss attributable to common stockholders per share, are each computed by dividing the net loss and the net loss attributable to common stockholders, respectively, by the sum of the weighted-average number of common shares outstanding during the reporting period, and, if dilutive, the incremental shares resulting from common stock equivalents, computed using the treasury stock method. The Company’s common stock equivalents include: stock options, unit purchase options, convertible preferred stock, and warrants. Notwithstanding, as the Company’s unaudited condensed consolidated financial results resulted in a net loss and a net loss attributable to common stockholders for all periods presented, basic and diluted net loss per share and net loss attributable to common stockholders per share are the same due to the exclusion of incremental shares resulting from common stock equivalents, as their inclusion would be anti-dilutive.

 

Segment Data

 

The Company manages its operations as a single operating segment for the purposes of assessing performance and making operating decisions. No revenue has been generated since inception, and all tangible assets are held in the United States.

 

JOBS Act Accounting Election

 

The Company is an “emerging growth company” or “EGC”, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, an EGC can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has irrevocably elected to avail itself of this exemption from new or revised accounting standards, and, therefore, will not be subject to the same new or revised accounting standards as public companies who are not an EGC.

 

Recent Accounting Pronouncements

 

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) - Part I - Accounting for Certain Financial Instruments with Down-Round Features, and Part 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. Principally, ASU 2017-11 amendments simplify the accounting for certain financial instruments with down-round features. The amendments require companies to disregard the down-round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. Companies that provide earnings per share (EPS) data will adjust their basic EPS calculation for the effect of the down-round feature when triggered (i.e., when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down-round feature) and will also recognize the effect of the trigger within equity. Additionally, ASU 2017-11 also addresses “navigational concerns” within the FASB ASC related to an indefinite deferral available to private companies with mandatorily redeemable financial instruments and certain noncontrolling interests, which has resulted in the existence of significant “pending content” in the ASC. The FASB decided to reclassify the indefinite deferral as a scope exception, which does not have an accounting effect. The guidance of ASU 2017-11 is effective for public business entities, as defined in the ASC Master Glossary, for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and for all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Earlier adoption is permitted for all entities as of the beginning of an interim period for which financial statements (interim or annual) have not been issued or have not been made available for issuance. The Company is evaluating the impact of this guidance on its unaudited condensed consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) - Scope of Modification Accounting. In ASU 2017-09, the FASB provides guidance on determining which changes to the terms and conditions of stock-based compensation arrangements require the application of “modification accounting” under ASC 718. Generally, ASC 718 modification accounting is not applicable if the stock-based arrangement immediately before and after the modification has the same fair value, vesting conditions, and balance sheet classification. The guidance of ASU 2017-09 is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for public business entities, as defined in the ASC Master Glossary, for periods for which financial statements have not yet been issued, and for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The Company adopted this guidance as of April 1, 2017, and it did not have an effect on the Company’s unaudited condensed consolidated financial statements.

 

11
 

 

Note 2 — Summary of Significant Accounting Policies (continued)

 

Recent Accounting Pronouncements (continued)

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which amends the guidance of FASB ASC Topic 805, Business Combinations (ASC 805) adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (disposals) of assets or businesses. The objective of ASU 2017-01 is to narrow the definition of what qualifies as a business under Topic 805 and to provide guidance for streamlining the analysis required to assess whether a transaction involves the acquisition (disposal) of a business. ASU 2017-01 provides a screen to assess when a set of assets and processes do not qualify as a business under Topic 805, reducing the number of transactions that need to be considered as possible business acquisitions. ASU 2017-01 also narrows the definition of output under Topic 805 to make it consistent with the description of outputs under Topic 606. The guidance of ASU 2017-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and early adoption is permitted under certain circumstances. The adoption of this guidance as of January 1, 2018 did not have an effect on the Company’s unaudited condensed consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, which amended the guidance of FASB ASC Topic 230, Statement of Cash Flows (ASC 230) on the classification of certain cash receipts and payments. The primary purpose of ASU 2016-15 is to reduce the diversity in practice which has resulted from a lack of consistent principles on this topic. The amendments of ASU 2016-15 add or clarify guidance on eight specific cash flow issues, including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. The guidance of ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance as of January 1, 2018 did not have an effect on the Company’s unaudited condensed consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and subsequently issued additional updates amending the guidance contained in Topic 606 (ASC 606), thereby affecting the guidance contained in ASU 2014-09. ASU 2014-09 and the subsequent ASC 606 updates will supersede and replace nearly all existing U.S. GAAP revenue recognition guidance. The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount equal to the consideration to which the entity expects to be entitled for those goods and services. ASU 2014-09 defines a five step process to achieve this core principle, and in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2017, including interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting the standard recognized at the date of adoption (which includes additional footnote disclosures). To date, since its inception, the Company has not generated any revenue, as such, the provisions of ASC 606 have not impacted the Company’s unaudited condensed consolidated results of operations or financial condition.

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (“ASU 2016-08”). The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations by amending certain existing illustrative examples and adding additional illustrative examples to assist in the application of the guidance. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in Topic 606. The guidance is effective for the Company beginning January 1, 2018, although early adoption is permitted beginning January 1, 2017. To date, since its inception, the Company has not generated any revenue, as such, the provisions of ASC 606 have not impacted the Company’s unaudited condensed consolidated results of operations or financial condition.

 

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”). The amendments in ASU 2016-10 clarify the following two aspects of Topic 606: (a) identifying performance obligations; and (b) the licensing implementation guidance. The amendments do not change the core principle of the guidance in Topic 606. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in Topic 606. The guidance is effective for the Company beginning January 1, 2018, although early adoption is permitted beginning January 1, 2017. To date, since its inception, the Company has not generated any revenue, as such, the provisions of ASC 606 have not impacted the Company’s unaudited condensed consolidated results of operations or financial condition.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which establishes a right-of-use (“ROU”) model requiring a lessee to recognize a ROU asset and a lease liability for all leases with terms greater-than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods with those fiscal years. A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of this guidance on its unaudited condensed consolidated financial position, results of operations, and cash flows.

 

12
 

 

Note 3 — Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following as of:

 

   March 31, 2018   December 31, 2017 
Security deposits  $14,250   $14,250 
Prepaid insurance   21,291    33,175 
Advanced payments to suppliers   78,292    41,042 
Total prepaid expenses and other current assets  $113,833   $88,467 

 

Note 4 — Equipment, Net

 

   March 31, 2018   December 31, 2017 
Research and development equipment  $13,656   $13,656 
Computer equipment   13,438    13,438 
    27,094    27,094 
Less: accumulated depreciation   (12,706)   (10,903)
Equipment, net  $14,388   $16,191 

 

Depreciation expense was $1,803 and $1,702 for the three months ended March 31, 2018 and 2017, respectively.

 

Note 5 — Agreement Related to Intellectual Property Right

 

Tufts Patent License Agreement - Antimicrobial Resorbable Ear Tubes

 

The Company executed a Patent License Agreement (the “Tufts Patent License Agreement”) with Tufts University and its co-owners, the Massachusetts Eye and Ear Infirmary and Massachusetts General Hospital (the “Licensors”) in November 2016. Pursuant to the Tufts Patent License Agreement, the Licensors granted the Company the exclusive right and license to certain patents in connection with the development and commercialization of antimicrobial resorbable ear tubes based on a proprietary aqueous silk technology conceived and developed by the Licensors. Upon execution of the Tufts Patent License Agreement, the Company paid the Licensors an upfront non-refundable fee of $50,000, with such fee recognized as research and development expense as of the transaction date.

 

The Company accounted for the Tufts Patent License Agreement as an asset acquisition as the license agreement did not meet the definition of a business pursuant to the guidance prescribed in FASB ASC Topic 805, Business Combinations, as the transaction principally resulted in the acquisition of intellectual property rights only. In this regard, the Company did not acquire any employees or tangible assets, or any processes, protocols, or operating systems. Additionally, at the time of the transaction, there were no activities being conducted related to the licensed patents. As such, the cost of the acquired intellectual property rights were recognized as an expense, as required, since this intangible asset was purchased from others for use in a research and development activity, and for which there are no alternative future uses.

 

The Tufts Patent License Agreement also provides for potential payments from the Company to the Licensors upon the achievement of certain product development and regulatory clearance milestones as well as royalty payments on net sales upon the commercialization of products developed utilizing the licensed patents. The Company will record as expense any contingent milestone payments or royalties in the period in which such liabilities are incurred.

 

Additionally, $35,837 and $0 was recognized as research and development expense related to patent fee reimbursement under the Tufts Patent License Agreement in the three months ended March 31, 2018 and 2017, respectively.

 

13
 

 

Note 6 — Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consisted of the following as of:

 

   March 31, 2018   December 31, 2017 
Accrued bonus  $39,265   $459,451 
Accrued payroll   145,937    125,088 
Accrued vacation   38,090    28,722 
Accrued board of director fees   72,500    82,500 
Accrued operating expenses   3,108    10,263 
Total accrued expenses and other current liabilities  $298,900   $706,024 

 

At March 31, 2018, the accrued bonus represents the estimated amount recognized on a pro rata basis during 2018 of the guaranteed bonus payment to the Company’s Chief Executive Officer (“CEO”) under the CEO Employment Agreement. At December 31, 2017, the accrued bonus represents the guaranteed bonus payment to the Company’s Chief Executive Officer (“CEO”) under the CEO Employment Agreement and discretionary bonus payments to other employees.

 

Accrued payroll represents earned but unpaid salary payable to the Company’s CEO under the terms of the Note and Security Purchase Agreement, including the corresponding Senior Secured Note, between the Company and Scopia Holdings LLC, wherein the CEO agreed to the payment of a reduced salary of $4,200 per month for the period July 1, 2017 through January 31, 2018, with such earned but unpaid amount to be paid to the CEO only upon the Senior Secured Note first being repaid-in-full. See Note 12 — Note and Securities Purchase Agreement, Senior Secured Note, and Series S Warrants, for a discussion of the Note and Security Purchase Agreement with Scopia Holdings LLC.

 

The accrued board of director fees at March 31, 2018 and December 31, 2017 represent amounts payable to all non-executive members of the board of directors, including at each of March 31, 2018 and December 31, 2017, $5,000 and $10,000, respectively, payable to a former board member previously deemed to be a related party,

 

14
 

 

Note 7 — Income Taxes

 

In the three months ended March 31, 2018 and 2017, the Company recognized a deferred tax benefit which was fully offset by a corresponding valuation allowance.

 

Under ASC 740, a “more-likely-than-not” criterion is applied when assessing the estimated realization of deferred tax assets through their utilization to reduce future taxable income, or with respect to a deferred tax asset for tax credit carryforward, to reduce future tax expense. A valuation allowance is established, when necessary, to reduce deferred tax assets, net of deferred tax liabilities, when the assessment indicates it is more-likely-than-not, the full or partial amount of the net deferred tax asset will not be realized. As a result of the evaluation of the positive and negative evidence bearing upon the estimated realizability of net deferred tax assets, and based on a history of operating losses, it is more-likely-than-not the deferred tax assets will not be realized, and therefore a valuation allowance reserve equal to the full amount of the deferred tax assets, net of deferred tax liabilities, has been recognized as a charge to income tax expense as of March 31, 2018 and December 31, 2017.

 

Deferred tax assets and deferred tax 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 of the change in the tax rate is recognized as income or expense in the period of the enacted change in tax rate. Changes in deferred tax assets and deferred tax liabilities are recorded in the provision for income taxes.

 

On December 22, 2017, the commonly referred to “Tax Cuts and Jobs Act of 2017” (Public Law No. 115-97), was enacted. The Tax Cuts and Jobs Act is a comprehensive revision to federal tax law which makes broad and complex changes to the U.S. tax code, including, but not limited to, reducing the U.S. federal corporate tax rate from 35% to 21%, eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized; creating a new limitation on deductible interest expense; changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017; and limitations on the deductibility of certain executive compensation.

 

In December 2017, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”), which addresses situations where the accounting is incomplete for the income tax effects of the Tax Cuts and Jobs Act of 2017. SAB 118 directs taxpayers to consider the impact of the Tax Cuts and Jobs Act of 2017 as “provisional” when the Company does not have the necessary information available, prepared, or analyzed, including computations, to finalize the accounting for the changes resulting from the Tax Cuts and Jobs Act of 2017. Companies are provided a measurement period of up to one year to obtain, prepare, and analyze information necessary to finalize the accounting for provisional amounts or amounts that cannot be estimated as of December 31, 2017.

 

The Tax Cuts and Jobs Act of 2017 impact on the tax provision of the Company for year ending December 31, 2017, resulted in the Company recognizing the provisional impact of the revaluation of deferred tax assets and deferred tax liabilities to 21% from 35%, resulting in an estimated $1.6 million tax expense, which was fully offset by a corresponding change in the valuation allowance applied to the net deferred tax assets.

 

The Company files income tax returns in the United States in federal and applicable state and local jurisdictions. The Company’s tax filings for the years 2016, 2015 and for its initial period of operations from June 26, 2014 (inception) through December 31, 2014, each remain subject to examination by taxing authorities.

 

15
 

 

Note 8 — Related Party Transactions

 

Effective October 2015, the Company entered into a three-year management services agreement through October 2018 with HCP/Advisors LLC, an affiliate of a former director of the Company, wherein HCP/Advisors LLC is to provide the Company with certain management services, including without limitation, identifying potential corporate opportunities, general business development, corporate development, corporate governance, marketing strategy, strategic development and planning, coordination with service providers, and other advisory services as may be mutually agreed upon. Pursuant to such agreement with HCP/Advisors LLC, the Company paid HCP/Advisors LLC an initial first month’s fee of $35,000 commencing as of November 1, 2015, and thereafter, a monthly fee of $25,000 through October 31, 2018. Under the agreement with HCP/Advisors LLC, the Company incurred an expense of $75,000 in each of the three months ended March 31, 2018 and 2017, included in “general and administrative expenses” in the accompanying unaudited condensed consolidated statements of operations.

 

Effective September 2016, the Company and HCFP/Strategy Advisors LLC, an affiliate of certain former directors and current officers of the Company, entered into a management consulting agreement referred to as the “HCFP Strategic Advisory Agreement”, which expired on May 14, 2017, as discussed below. Under the HCFP Strategic Advisory Agreement, HCFP/Strategy Advisors LLC had been engaged for an initial term of five months from September 14, 2016 to February 14, 2017, to provide various management consulting advisory services, including: to provide strategic business planning, to identify and assist with potential sources of financing arrangements, to promote the Company to various potential investors, and to provide strategic advisory services as reasonably requested by the Company. The HCFP Strategic Advisory Agreement provided for an initial total fee of $110,000, with $30,000 paid upon execution of the agreement and four payments of $20,000 per month from October 2016 to January 2017. Subsequently, on February 17, 2017, the Company and HCFP/Strategy Advisors LLC executed an extension of the HCFP Strategic Advisory Agreement, effective as of February 15, 2017, extending the services from February 15, 2017 to May 14, 2017, and obligating the Company to make payments of $20,000 per month in each of February, March, and April 2017. The Company did not further renew the HCFP Strategic Advisory Agreement after the May 14, 2017 expiration date. Previously, at December 31, 2016, the Company recognized a $10,000 estimated accrued expense liability for HCFP/Strategy Advisors LLC asserted out-of-pocket expenses under the HCFP Strategic Advisory Agreement in effect as of December 31, 2016. Subsequently, at June 30, 2017, the Company reversed such $10,000 estimated accrued expense liability, as supporting documentation had not been provided by HCFP/Strategy Advisors LLC. At June 30, 2017, the Company had made all contractually obligated payments to, and disclaimed any further payment obligations, under the HCFP Strategic Advisory Agreement. The Company incurred expense of $75,000 in the three months ended March 31, 2017, under the HCFP Strategic Advisory Agreement, with such expense included in “general and administrative expenses” in the accompanying unaudited condensed consolidated statements of operations.

 

In January 2017, the Company entered into an agreement with Xzerta Trading LLC d/b/a HCFP/Capital Markets (“HCFP/Capital Markets”), an affiliate of certain former directors and current officers of the Company, wherein HCFP/Capital Markets was engaged to be the Company’s exclusive placement agent in an offering of securities (“the HCFP/Capital Markets Placement Agent Agreement”), including the Series A Preferred Stock Units private placement transaction. Under the HCFP /Capital Markets Placement Agent Agreement, HCFP/Capital Markets was paid a fee of 7.0% of the gross proceeds realized in the securities offering, plus reimbursement of certain out-of-pocket costs. The term of the HCFP/Capital Markets Placement Agent Agreement is from the January 2017 execution date to the completion or termination of any other potential transactions in conjunction with the Series A Preferred Stock Units private placement. In connection with the issue of Series A Preferred Stock Units, fees paid to HCFP/Capital Markets of $177,576 are included in “Loss on issuance of Series A Preferred Stock Units” in the accompanying unaudited condensed consolidated statements of operations.

 

Effective June 30, 2017, the Company and Michael J. Glennon, Vice Chairman and member of the board of directors, agreed to terminate the consulting agreement in effect since October 1, 2016, under which Mr. Glennon agreed to provide us with services and advice relating to the successful development and commercialization of medical device products. Effective as of December 31, 2016, Mr. Glennon waived his right to compensation under the consulting agreement for the year ended December 31, 2016, and, effective as of March 31, 2017, Mr. Glennon further waived his right to compensation under the consulting agreement for the period January 1, 2017 through June 30, 2017.

 

Effective November 2016, the Company entered into a consulting agreement with Patrick Glennon, a related-party who is the brother of Michael J. Glennon, Vice Chairman and a member of the Company’s board of directors (the “Patrick Glennon Consulting Agreement”). Under the terms of the Patrick Glennon Consulting Agreement, Mr. Patrick Glennon will provide consulting support and advice with respect to the development and commercialization of resorbable ear tubes. The sole compensation for such services is the issuance on November 28, 2016 of stock options to purchase 20,000 shares of the Company’s common stock, with an exercise price of $9.50 per share, and vesting ratably on a quarterly basis commencing December 31, 2016 through September 30, 2019.

 

16
 

 

Note 9 — Commitments and Contingencies

 

Employment Agreements & Compensation

 

Chief Executive Officer Employment Agreement

 

Effective November 1, 2014, the Company entered into a five year employment agreement with Dr. Lishan Aklog, M.D. to serve as its Chief Executive Officer (“CEO Employment Agreement”), initially with an annual base salary of $240,000 through October 31, 2015, and then $295,000 per year effective November 1, 2015. Additionally, effective as of January 1, 2016, Dr. Aklog’s employment agreement provides for a guaranteed annual bonus equal to 50% of base salary, beginning on January 1 of each year, as well as also being eligible to earn additional discretionary annual performance bonuses upon meeting certain objectives as determined by the board of directors.

 

Under the terms of the Note and Security Purchase Agreement, including the corresponding Senior Secured Note, between the Company and Scopia Holdings LLC, the CEO agreed to the payment of a reduced salary of $4,200 per month for the period July 1, 2017 through January 31, 2018, with such earned but unpaid amount to be paid to the CEO only upon the Senior Secured Note first being repaid-in-full. See Note 12 — Note and Securities Purchase Agreement, Senior Secured Note, and Series S Warrants, for a discussion of the Note and Security Purchase Agreement with Scopia Holdings LLC.

 

If Dr. Aklog’s employment is terminated by the Company without “cause” or by Dr. Aklog with “good reason” (as such terms are defined in the employment agreement), Dr. Aklog is entitled to be paid his base salary through the end of the remaining term of the CEO Employment Agreement at 150% of base salary, valid expense reimbursements and accrued but unused vacation pay. The CEO Employment Agreement contains provisions for the protection of the Company’s intellectual property and contains non-compete restrictions in the event of his termination other than without “cause” or by the Company with “good reason.”

 

Executive Vice President and Chief Financial Officer Employment Agreement

 

On March 20, 2017, we entered into a two year employment agreement with Dennis M. McGrath, to serve as the Company’s Executive Vice President and Chief Financial Officer, with an annual base salary of $285,000, a discretionary annual performance bonus with a target of 50% of the then current annual base salary, based upon his performance and the Company’s performance over the preceding year, as determined by the compensation committee of the board of directors, and, for the period May 1, 2017 to March 31, 2018, a housing and travel allowance of up to $2,250 per month (“CFO Employment Agreement”). The CFO Employment Agreement contains provisions for the protection of the Company’s intellectual property and contains non-compete restrictions in the event of his termination other than without “cause” or by the Company with “good reason”.

 

Chief Medical Officer Employment Agreement

 

Effective July 1, 2016, we entered into a five-year employment agreement with Dr. Brian J. deGuzman, M.D. to serve as the Company’s Chief Medical Officer (“CMO”) with a base annual salary of $285,000; an initial bonus of $50,000 for services provided before the employment agreement’s effective date, and, a discretionary annual performance bonus with a target of 40% of the then current annual base salary, upon meeting certain objectives as determined by the compensation committee of the board of directors (“CMO Employment Agreement”). The CMO Employment Agreement contains provisions for the protection of the Company’s intellectual property and contains non-compete restrictions in the event of his termination other than without “cause” or by the Company with “good reason”.

 

Leases

 

The Company leases office space for its corporate office on a month-to-month basis, upon the lease agreement expiration on May 31, 2017. The lease agreement may be cancelled by the Company with three months written notice The lease agreement includes a 5% increase in monthly rent effective on each twelve-month anniversary date. Total rent expense incurred under the corporate office space lease arrangement was $30,922 and $42,126 for the three months March 31, 2018 and 2017, respectively.

 

Additionally, the Company had previously rented access to a research and development facility, for monthly rent of $1,000, on a month-to-month basis under which either the landlord or the Company could cancel the rental arrangement at any time. Effective February 28, 2017, the Company ceased use of the research and development facility and canceled the rental arrangement. Total rental expense under this research and development facility rental arrangement amounted to $2,000 for the three months ended March 31, 2017.

 

Legal Proceedings

 

In the normal course of business, from time-to-time, the Company may be subject to claims in legal proceedings. However, the Company does not believe it is currently a party to any pending legal actions. Notwithstanding, legal proceedings are subject-to inherent uncertainties, and an unfavorable outcome could include monetary damages, and in such event, could result in a material adverse impact on the Company’s business, financial position, results of operations, and /or cash flows.

 

17
 

 

Note 10 — Stock-Based Compensation

 

The 2014 Long-Term Incentive Equity Plan (the “2014 Stock Plan”), adopted by the Company’s board of directors and stockholders in November 2014, is designed to enable the Company to offer employees, officers, directors, and consultants, as defined, an opportunity to acquire a proprietary interest in the Company. The types of awards that may be granted under the 2014 Stock Plan include stock options, stock appreciation rights, restricted stock, and other stock-based awards subject to limitations under applicable law. All awards are subject to approval by the compensation committee of the Company’s board of directors.

 

The following table summarizes information about stock options outstanding for the periods presented below:

 

      Weighted     
   Number   Average   Aggregate 
   Stock   Exercise   Intrinsic 
   Options   Price   Value 
Outstanding at December 31, 2017   1,936,924   $5.14      
Granted   1,265,216   $2.14      
Exercised      $      
Forfeited   (195,108)  $5.00      
Outstanding at March 31, 2018   3,007,032   $3.92   $ 
Vested and exercisable at March 31, 2018   1,100,981   $4.88   $ 
Unvested at March 31, 2018   1,906,051   $3.36   $ 
                
Outstanding at December 31, 2016   1,633,313   $5.14      
Granted   380,000   $5.35      
Exercised      $      
Forfeited   (76,389)  $5.00      
Outstanding at December 31, 2017   1,936,924   $5.19   $ 
Vested and exercisable at December 31, 2017   964,080   $5.14   $ 
Unvested at December 31, 2017   972,844   $5.23   $ 

 

The aggregate intrinsic value is computed as the difference between the exercise price of the underlying stock options and the quoted price of the common stock on December 31, 2017, to the extent the exercise price is less than the quoted price. At March 31, 2018, the weighted average remaining contractual term was 8.9 years for stock options outstanding and 8.1 years for stock options vested and exercisable.

 

During the three months year ended March 31, 2018, an aggregate of 1,265,216 stock options were granted, each with a ten year contractual term from date-of-grant, and each vesting ratably on a quarterly basis over a three year period commencing March 31, 2018, including: in January 2018, 175,000 stock options with an exercise price of $2.96 granted to the Company’s VP Technology and Product Development, and in February 2018, a total of 500,000 stock options granted to non-executive members of the Company’s board of directors, and a total of 590,216 stock options granted to employees, each with an exercise price of $2.01 per share. Additionally, in February 2018, a total of 195,108 previously granted stock options were forfeited in connection with the resignation of two members from the Company’s board of directors.

 

During the year ended December 31, 2017, the Company granted a total of 380,000 stock options, each with a ten year contractual term from date-of-grant, as follows:

 

March 2017 - 25,000 stock options with an exercise price of $5.01 per share, vesting ratably on a quarterly basis over a three year period commencing June 30, 2017, granted to a new member of the Company’s medical advisory board, and, 250,000 stock options granted outside the 2014 Stock Plan, with an exercise price of $5.95 per share, vesting ratably on a quarterly basis over a three year period commencing June 30, 2017, to the Company’s new CFO;
   
July 2017 - 50,000 stock options with an exercise price of $4.50 per share, vesting ratably on a quarterly basis over a three year period commencing September 30, 2017, granted to the Company’s Corporate Controller;
   
August 2017 - 40,000 stock options with an exercise price of $2.98 per share, vesting ratably on a quarterly basis over a three year period commencing September 30, 2017, granted to a new member of the Board of Directors;
   
October 2017 - 15,000 stock options with an exercise price of $5.11 per share, vesting ratably on an annual basis over a three year period commencing October 2018, granted to a consultant.

 

In March 2017, 76,389 stock options were forfeited upon the resignation of the Company’s former CFO, as discussed below.

 

A total of 2,951,081 shares of common stock of the Company are reserved for issuance under the 2014 Stock Plan. As of March 31, 2018, 444,903 shares of common stock of the Company were available for grant under the 2014 Stock Plan, excluding stock options granted outside the 2014 Stock Plan, including 250,000 in 2017 and 250,854 in 2016.

 

18
 

 

Note 10 — Stock-Based Compensation (continued)

 

The Company uses the Black-Scholes valuation model to estimate the fair value of stock options, which requires the Company to make certain estimates and assumptions, with the weighted-average valuation assumptions for stock-based awards, as follows: weighted-average risk-free interest rate is based on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period commensurate with the assumed expected option term; expected term of stock options represents the period of time stock options are expected to be outstanding, which for employees is the expected term derived using the simplified method and for non-employees is the contractual term; expected stock price volatility is based on historical stock price volatilities of similar entities within the Company’s industry over the period commensurate with the expected term of the stock option; and, expected dividend yield is based on annual dividends of $0.00 as the Company has not historically paid, and does not expect for the foreseeable future to pay, a dividend.

 

The stock-based compensation expense related to stock options granted to employees and directors is based on the grant-date fair value, and for stock options granted to non-employees is based on the vesting date fair value, with the cost recognized on a straight-line basis over the award’s requisite service period. Stock-based compensation expense recognized for the periods indicated was as follows:

 

   Three Months Ended March 31, 
   2018   2017 
General and administrative expenses  $219,394   $242,452 
Research and development expenses   51,892    30,228 
Total  $271,286   $272,680 

 

Included in general and administrative expenses for the three months ended March 31, 2017 is $51,389 of stock-based compensation expense resulting from the March 31, 2017 modifications to the stock option grant to the Company’s former CFO. Previously, on April 28, 2016, upon the closing of the Company’s IPO, the former CFO was granted 125,000 stock options at an exercise price of $5.00 per share. On March 31, 2017, the April 28, 2016 stock option agreement was amended, wherein the stock option grant continued to vest monthly in April, May, and June 2017, and the 48,611 vested stock options are exercisable until April 28, 2019, with the remaining 76,389 stock options forfeited effective March 31, 2017.

 

At March 31, 2018, total unrecognized stock-based compensation expense of $2,165,631 is expected to be recognized over the weighted average remaining requisite service period of 1.9 years. At December 31, 2017, total unrecognized stock-based compensation expense of $1,573,988 is expected to be recognized over the weighted average remaining requisite service period of 1.5 years.

 

Stock-based compensation expense recognized for stock options granted to employees and members of the board of directors during the three months ended March 31, 2018 and 2017, was based on a weighted average fair value of $1.23 per share and $1.55 per share, respectively, calculated using the following weighted average Black-Scholes valuation model assumptions:

 

   Three Months Ended March 31, 
   2018   2017 
Risk free interest rate   2.0%   1.5%
Expected term of stock options (in years)   5.8    5.8 
Expected stock price volatility   50%   50%
Expected dividend yield   0%   0%

 

Stock-based compensation expense recognized for stock options granted to non-employees during the three months ended March 31, 2018 and 2017, was based on a weighted average fair value of $2.59 per share and $4.23 per share, respectively, calculated using the following weighted average Black-Scholes valuation model assumptions

 

   Three Months Ended March 31, 
   2018   2017 
Risk free interest rate   2.3%   2.3%
Expected term of stock options (in years)   8.2    9.4 
Expected stock price volatility   60%   60%
Expected dividend yield   0%   0%

 

19
 

 

Note 11 — Financial Instruments Fair Value Measurements

 

Recurring Fair Value Measurements

 

The Series A Warrants and the Series A Convertible Preferred Stock conversion option derivative liabilities as of March 31, 2018 and December 31, 2017, are summarized in the fair value hierarchy table(1), as follows:

 

   Fair Value Measurement on a Recurring Basis at Reporting Date Using: 
   Level-1   Level-2   Level-3     
   Inputs   Inputs   Inputs   Total 
March 31, 2018(2)                    
Series A Warrants derivative liability  $   $   $   $ 
Series A Convertible Preferred Stock conversion option derivative liability                
Totals  $   $   $   $ 
                     
December 31, 2017                    
Series A Warrants derivative liability  $   $   $761,123   $761,123 
Series A Convertible Preferred Stock conversion option derivative liability           212,217    212,217 
Totals  $   $   $973,340   $973,340 

 

(1)As noted above, as presented in the fair value hierarchy table, Level-1 represents quoted prices in active markets for identical items, Level-2 represents significant other observable inputs, and Level-3 represents significant unobservable inputs.
  
(2)As of March 31, 2018, each of the Series A Warrants derivative liability and the Series A-1 Convertible Preferred Stock conversion option derivative liability were fully extinguished as of the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer, upon the exchange of all shares of Series A Convertible Preferred Stock and Series A Warrants - as discussed herein below.

 

The Series A Preferred Stock Units were issued in a private placement with three closings occurring in the three months ended March 31, 2017, and were each comprised of one share of Series A Convertible Preferred Stock and one Series A Warrant. At the option of their respective holder, the Series A Convertible Preferred Stock may be converted into shares of common stock of the Company and the Series A Warrant may be exercised for a share of common stock of the Company. See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants for a further discussion of the Series A Preferred Stock Units private placement, the Series A Convertible Preferred Stock, and the Series A Warrant.

 

The Series A Warrant and the Series A Convertible Preferred Stock conversion option were each determined to be a derivative liability under FASB ASC 815, as the Series A Convertible Preferred Stock common stock exchange factor denominator and the Series A Warrant exercise price are each subject to potential adjustment resulting from future financing transactions, under certain conditions, along with certain other provisions which may result in required or potential full or partial cash settlement. The respective Series A Warrants and the Series A Convertible Preferred Stock conversion option derivative liability are classified as a current liability in the unaudited condensed consolidated balance sheet, and each were initially measured at fair value at the time of issuance and are subsequently remeasured at fair value on a recurring basis at each reporting period date, with changes in fair value recognized as other income or expense in the unaudited condensed consolidated statement of operations.

 

The reconciliation of each of the Series A Warrants and the Series A Convertible Preferred Stock conversion option derivative liability for the periods noted are as follows:

 

       Series A 
       Convertible 
   Series A   Preferred Stock 
Derivative Liability - March 31, 2018  Warrants   Conversion Option 
Balance at December 31, 2017  $761,123   $212,217 
Change in fair value   (246,561)   (64,913)
Series A and Series A-1 Exchange Offer - March 15, 2018   (514,562)   (147,304)
Balance at March 31, 2018  $   $ 

 

As of March 31, 2018, each of the Series A Warrants derivative liability and the Series A-1 Convertible Preferred Stock conversion option derivative liability were fully extinguished as of the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer, upon all of the issued and outstanding shares of Series A Convertible Preferred Stock exchanged for Series B Convertible Preferred Stock and the Series A Warrants exchanged for Series Z Warrants - as discussed herein below.

 

20
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

       Series A 
       Convertible 
   Series A   Preferred Stock 
Derivative Liability - December 31, 2017  Warrants   Conversion Option 
Balance at December 31, 2016  $   $ 
Initial fair value on dates of issuance   4,050,706    1,221,963 
Change in fair value   (1,942,501)   (643,318)
Conversion of Series A Convertible Preferred Stock       (27,335)
Series A Exchange Offer - November 17, 2017   (1,347,082)   (339,093)
Balance at December 31, 2017  $761,123   $212,217 

 

The number of Series A Warrants and shares of Series A Convertible Preferred Stock each issued and outstanding for the periods noted, is as follows:

 

       Series A 
   Series A   Convertible 
Issued and Outstanding - March 31, 2018  Warrants   Preferred Stock 
Issued and outstanding as of December 31, 2017   268,001    249,667 
Series A and Series A-1 Exchange Offer - March 15, 2018   (268,001)   (249,667)
Issued and outstanding as of March 31, 2018        

 

As of March 31, 2018, there were no issued and outstanding Series A Warrants and shares of Series A Convertible Preferred Stock, nor Series A-1 Warrants and shares of Series A-1 Convertible Preferred Stock, as each were fully exchanged for shares Series B Convertible Preferred Stock and Series Z Warrants, respectively, on the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer - as discussed herein below.

 

       Series A 
   Series A   Convertible 
Issued and Outstanding - December 31, 2017  Warrants   Preferred Stock 
Issued and outstanding as of December 31, 2016        
Issued in Series A Preferred Stock Units private placement   422,838    422,838 
Conversion of Series A Convertible Preferred Stock       (18,334)
Series A Exchange Offer - November 17, 2017   (154,837)   (154,837)
Issued and outstanding as of December 31, 2017   268,001    249,667 

 

Change in Fair Value

 

The change in estimated fair value, including fair value adjustments on the March 15, 2018 date of the Series A and Series A-1 Exchange Offer on March 15, 2018, during the three months ended March 31, 2018, resulted in the recognition of other expense of $96,480 and other income of $64,913, with corresponding increase in the Series A Warrants derivative liability and a decrease in the Series A Convertible Preferred Stock conversion option derivative liability, respectively.

 

The change in estimated fair value during the three months ended March 31, 2017, resulted in the recognition of other income of $786,397 and $224,065, with corresponding decrease in each of the Series A Warrants derivative liability and the Series A Convertible Preferred Stock conversion option derivative liability, respectively.

 

21
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Fair Value Assumptions - Derivative Liability - Series A Warrants and Series A Convertible Preferred Stock Conversion Option

 

The initial issue date and subsequent recurring reporting period date estimated fair value of each of the Series A Warrants derivative liability and the Series A Convertible Preferred Stock conversion option derivative liability, were estimated using a Monte Carlo simulation valuation model using the Company’s common stock price, the Company’s dividend yield, the risk-free rates based on U.S. Treasury security yields, and certain other Level-3 inputs to take into account the probabilities of certain events occurring over their respective life, including, assumptions regarding the estimated volatility in the value of the Company’s common stock price and the likelihood and timing of future dilutive transactions, as applicable, using the following assumptions as of the dates indicated:

 

Fair Value Assumptions  March 15,   December 31, 
Series A Warrants Derivative Liability  2018(1)   2017 
Calculated aggregate fair value  $514,562   $761,123 
Series A Warrants outstanding   268,001    268,001 
Value of common stock  $1.70   $2.29 
Exercise price per share - Series A Warrant  $6.61   $6.61 
Exercise price per share - Series X Warrant  $6.00   $6.00 
Expected term (years)   6.1    6.3 
Volatility   59%   55%
Risk free rate   2.7%   2.2%
Dividend yield   0%   0%

 

Fair Value Assumptions        
Series A Convertible Preferred Stock  March 15,   December 31 
Conversion Option Derivative Liability  2018(1)   2017 
Calculated aggregate fair value  $147,304   $212,217 
Series A Convertible Preferred Stock shares   249,667    249,667 
Value of common stock  $1.70   $2.29 
Common stock exchange factor numerator  $6.00   $6.00 
Common stock exchange factor denominator  $4.97   $4.97 
Expected term (years)   6.1    6.3 
Volatility   59%   55%
Risk-free interest rate   2.7%   2.2%
Dividend yield   0%   0%

 

(1) As the Series A Warrants and shares of Series A Convertible Preferred Stock were each fully exchanged on the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer, March 15, 2018 was the date of the final estimated fair value of each of the Series A Warrant and the Series A Convertible Preferred Stock conversion option derivative liability. As noted above, as of March 31, 2018, each of the Series A Warrants and the Series A-1 Convertible Preferred Stock conversion option derivative liability were fully extinguished on the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer - as discussed herein below.

 

22
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Fair Value Assumptions - Derivative Liability - Series A Warrants and Series A Convertible Preferred Stock Conversion Option (continued)

 

       Issue 
       Dates’ 
       Aggregated 
Fair Value Assumptions  March 31,   Weighted 
Series A Warrants Derivative Liability  2017   Average 
Calculated aggregate fair value  $3,264,309   $4,050,706 
Series A Warrants outstanding   422,838    422,838 
Value of common stock  $5.00   $5.73 
Exercise price per share - Series A Warrant  $8.00   $8.00 
Exercise price per share - Series X Warrant  $6.00   $6.00 
Expected term (years)   7.1    7.2 
Volatility   48%   47%
Risk free rate   2.2%   2.3%
Dividend yield   0%   0%

 

       Issue 
       Dates’ 
Fair Value Assumptions      Aggregated 
Series A Convertible Preferred Stock  March 31,   Weighted 
Conversion Option Derivative Liability  2017   Average 
Calculated aggregate fair value  $997,898   $1,221,963 
Series A Convertible Preferred Stock shares   422,838    422,838 
Value of common stock  $5.00   $5.73 
Common stock exchange factor numerator  $6.00   $6.00 
Common stock exchange factor denominator  $6.00   $6.00 
Expected term (years)   7.1    7.2 
Volatility   48%   47%
Risk-free interest rate   2.2%   2.3%
Dividend yield   0%   0%

 

Series A and Series A-1 Exchange Offer - Series B Convertible Preferred Stock and Series Z Warrants - March 15, 2018

 

The Series A and Series A-1 Exchange Offer, completed on March 15, 2018, was offered to and accepted by all holders of both the Series A Convertible Preferred Stock and Series A Warrants, and the Series A-1 Convertible Preferred Stock and Series A-1 Warrants, was as follows: one (1) share of Series A Convertible Preferred Stock exchanged for two (2) shares of Series B Convertible Preferred Stock, and one (1) Series A Warrant exchanged for five (5) Series Z Warrants; and one (1) share of Series A-1 Convertible Preferred Stock exchanged for 1.33 shares of Series B Convertible Preferred Stock, and one (1) Series A-1 Warrant exchanged for five (5) Series Z Warrants - referred to herein as the “Series A and Series A-1 Exchange Offer” and the “March 15, 2018 Exchange Date”.

 

On the March 15, 2018 Exchange Date: (i) a total of 975,568 shares of Series B Convertible Preferred Stock were issued upon the exchange of 249,667 shares of Series A Convertible Preferred Stock and 357,259 shares of Series A-1 Convertible Preferred Stock; and, (ii) a total of 2,739,190 Series Z Warrants were issued upon the exchange of 268,001 Series A Warrants and 279,837 Series A-1 Warrants. See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants for a further discussion of the Series B Convertible Preferred Stock and the Series Z Warrant.

 

Consequently, as of March 31, 2018, there were no issued and outstanding shares of Series A Convertible Preferred Stock and Series A Warrants, nor shares of Series A-1 Convertible Preferred Stock and Series A-1 Warrants, as each were fully exchanged for shares of Series B Convertible Preferred Stock and Series Z Warrants, respectively, on the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer. Additionally, each of the Series A Warrants and the Series A-1 Convertible Preferred Stock conversion option derivative liability were fully extinguished as of the March 15, 2018 Exchange Date of the Series A and Series A-1 Exchange Offer, upon the exchange of all shares of Series A Convertible Preferred Stock and Series A Warrants.

 

23
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Series A and Series A-1 Exchange Offer - March 15, 2018 -

Series B Convertible Preferred Stock Issued Upon Exchange of Series A Convertible Preferred Stock

Series Z Warrants Issued Upon Exchange Of Series A Warrants

 

The Series A and Series A-1 Exchange Offer resulted in the extinguishment of: 249,667 shares of Series A Convertible Preferred Stock along with the corresponding (bifurcated) conversion option derivative liability, and, 268,001 Series A Warrants, resulting from the issue upon exchange of: 499,334 shares of Series B Convertible Preferred Stock and 1,340,005 Series Z Warrants, each as discussed herein below.

 

Series A and Series A-1 Exchange Offer - March 15, 2018

Series B Convertible Preferred Stock Issued Upon Exchange of Series A Convertible Preferred Stock

 

The estimated fair value of the consideration given of $873,835 of the issued 499,334 shares of Series B Convertible Preferred Stock, as compared to the extinguishment of both the (temporary equity) carrying value of 249,667 shares of Series A Convertible Preferred Stock and the estimated fair value of the corresponding conversion option derivative liability of $147,304, resulted in an excess of $726,531 recognized as a deemed dividend charged to accumulated deficit on the March 15, 2018 Exchange Date, with such deemed dividend included as a component of net loss attributable to common stockholders, summarized as follows:

 

   Series A 
   Series A-1 
Deemed Dividend Charged to Accumulated Deficit  Exchange Offer 
Series B Convertible Preferred Stock Issued  March 15, 2018 
Series A Convertible Preferred Stock and Conversion Option Derivative Liability Extinguished  Exchange Date 
Fair value - 499,334 shares of Series B Convertible Preferred Stock issued  $873,835 
Less: fair value - Series A Convertible Preferred Stock conversion option derivative liability extinguished   147,304 
Less: carrying value - 249,667 shares of Series A Convertible Preferred Stock exchanged    
Deemed dividend charged to accumulated deficit  $726,531 

 

The March 15, 2018 Exchange Date estimated fair value of $873,835 of the 499,334 shares of Series B Convertible Preferred Stock issued upon the exchange of 249,667 Series A Convertible Preferred Stock was computed using a combination of the present value of its cash flows using a synthetic credit rating analysis’ required rate of return and the Black-Scholes option pricing model, using the following assumptions:

 

   Series A 
   Series A-1 
   Exchange Offer 
Fair Value Assumptions  March 15, 2018 
Series B Convertible Preferred Stock  Exchange Date 
Aggregate fair value  $873,835 
Series B Convertible Preferred Stock shares   499,334 
Required rate of return   27.0%
Common stock conversion factor numerator  $3.00 
Common stock conversion factor denominator  $3.00 
Value of common stock  $1.70 
Expected term (years)   6.1 
Volatility   59%
Risk free rate   2.7%
Dividend yield   0%

 

The March 15, 2018 Exchange Date estimated fair value of $147,304 of the extinguished Series A Convertible Preferred Stock conversion option derivative liability was estimated using a Monte Carlo simulation valuation model, using the Company’s common stock price and certain other Level-3 inputs to take into account the probabilities of certain events occurring over their respective life, using the following assumptions.

 

Fair Value Assumptions  March 15, 2018 
Series A Convertible Preferred Stock Conversion Option Derivative Liability  Exchange Date 
Aggregate fair value  $147,304 
Series A Convertible Preferred Stock shares   249,667 
Value of common stock  $1.70 
Common stock exchange factor numerator  $6.00 
Common stock exchange factor denominator  $4.97 
Expected term (years)   6.1 
Volatility   59%
Risk-free interest rate   2.7%
Dividend yield   0%

 

24
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Series A and Series A-1 Exchange Offer - March 15, 2018

Series B Convertible Preferred Stock Issued Upon Exchange of Series A Convertible Preferred Stock (continued)

 

The Series A Convertible Preferred Stock is classified in temporary equity in the unaudited condensed consolidated balance sheet and has a carrying value of $0 resulting from the issuance date initial fair values of the Series A Warrant derivative liability and the Series A Convertible Preferred Stock conversion option derivative liability being in excess of the Series A Preferred Stock Units private placement issuance gross proceeds, with such excess recognized as a current period loss in the unaudited condensed consolidated statement of operations. See Note 13, Series A Convertible Preferred Stock, Stockholders’ Deficit, and Warrants, for a further discussion of the Series A Preferred Stock Units private placement and the Series A Convertible Preferred Stock.

 

Series A and Series A-1 Exchange Offer - March 15, 2018 -

Series Z Warrants Issued Upon Exchange of Series A Warrants

 

As noted above, the Series A Warrants derivative liability fair value was initially adjusted to the March 15, 2018 Exchange Date estimated fair value of $514,562, resulting in income of $246,561. The consideration given estimated fair value of $857,603 of the 1,340,005 Series Z Warrants issued upon the exchange of the 268,001 Series A Warrants, with a fair value of $514,562, resulted in an expense of $343,041, with a corresponding recognition of such amount in additional paid-in capital, as the Series Z Warrants are equity classified. Accordingly the net impact of the March 15, 2018 Series A Warrants fair value adjustment of $246,551 of income together with the $343,041 of expense from the issue of the Series Z Warrants, resulted in a net expense of $96,480 recognized in other income or expense in the unaudited condensed consolidated statement of operations. The carrying value of the Series Z Warrants are their March 15, 2018 Exchange Date estimated fair value of $857,603, comprised of the derecognition of the Series A Warrant derivate liability of $514,562, plus the $343,041 of the difference in estimated fair value of the Series Z Warrants issued as compared to the estimated fair value of the Series A Warrants derivative liability on the March 15, 2018 Exchange Date.

 

The March 15, 2018 Exchange Date estimated fair value of $857,603 of the 1,340,005 Series Z Warrants issued upon the exchange of 268,001 Series A Warrants was computed using a Black-Scholes valuation model, using the following assumptions:

 

Fair Value Assumptions  March 15, 2018 
Series Z Warrants issued upon exchange of Series A Warrants  Exchange Date 
Aggregate fair value  $857,603 
Series Z Warrants issued upon exchange of Series A Warrants   1,340,005 
Exercise price per share - Series Z Warrant  $3.00 
Value of common stock  $1.70 
Expected term (years)   6.1 
Volatility   59%
Risk free rate   2.7%
Dividend yield   0%

 

25
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Series A and Series A-1 Exchange Offer - March 15, 2018 -

Series B Convertible Preferred Stock Issued Upon Exchange of Series A-1 Convertible Preferred Stock

Series Z Warrants Issued Upon Exchange of Series A-1 Warrants

 

The Series A and Series A-1 Exchange Offer resulted in the extinguishment of: 357,259 shares of Series A-1 Convertible Preferred Stock and, 279,837 Series A-1 Warrants, resulting from the issue upon exchange of: 476,234 shares of Series B Convertible Preferred Stock and 1,399,185 Series Z Warrants, each as discussed herein below.

 

Series A and Series A-1 Exchange Offer - March 15, 2018

Series B Convertible Preferred Stock Issued Upon Exchange of Series A-1 Convertible Preferred Stock

 

The fair value of the consideration given of the issued 476,234 shares of Series B Convertible Preferred Stock was less than the carrying value of the equity-classified Series A-1 Convertible Preferred Stock, resulting in an increase to additional paid in capital of $199,241 on the March 15, 2018 Exchange Date, with such amount included as a component of net loss attributable to attributable to common stockholders, summarized as follows:

 

   Series A 
   Series A-1 
Series B Convertible Preferred Stock Issued  Exchange Offer 
Series A-1 Convertible Preferred Stock Extinguished  March 15, 2018 
Deemed Dividend Charged to Accumulated Deficit  Exchange Date 
Fair value - 476,234 shares of Series B Convertible Preferred Stock issued  $833,410 
Less: carrying value - 357,259 shares of Series A-1 Convertible Preferred Stock exchanged   1,032,650 
Increase - additional paid-in capital  $199,241 

 

The March 15, 2018 Exchange Date estimated fair value of $833,410 of the 476.234 shares of Series B Convertible Preferred Stock issued upon exchange of 357,259 shares of Series A-1 Convertible Preferred Stock was computed using a combination of the present value of its cash flows using a synthetic credit rating analysis required rate of return and the Black-Scholes option pricing model, using the following assumptions:

 

   Series A 
   Series A-1 
   Exchange Offer 
Fair Value Assumptions  March 15, 2018 
Series B Convertible Preferred Stock - issued upon exchange of Series A-1 Convertible Preferred Stock  Exchange Date 
Aggregate fair value  $833,410 
Series B Convertible Preferred Stock shares   476,234 
Required rate of return   27.0%
Common stock conversion factor numerator  $3.00 
Common stock conversion factor denominator  $3.00 
Value of common stock  $1.70 
Expected term (years)   6.1 
Volatility   59%
Risk free rate   2.7%
Dividend yield   0%

 

26
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Series A and Series A-1 Exchange Offer - March 15, 2018 (continued)

Series Z Warrants Issued Upon Exchange of Series A-1 Warrants

 

The difference in the March 15, 2018 Exchange Date estimated fair value of $895,478 of the 1,399,185 Series Z Warrants issued as compared to the $545,682 of the 279,837 Series A-1 Warrants exchanged, resulted in a modification expense of $349,796, included in other income (expense) in the unaudited condensed consolidated statement of operations, with a corresponding increase to additional paid in capital, as the Series Z Warrants are equity-classified, summarized as follows:

 

   Series A 
   Series A-1 
   Exchange Offer 
Series Z Warrants - issued issued upon exchange of Series A-1 Warrants  March 15, 2018 
Series A-1 Warrants Exchange  Exchange Date 
Fair value - 1,399,185 Series Z Warrants issued  $895,478 
Less: fair value - 279,837 Series A-1 Warrants exchanged   545,682 
Modification expense /increase to additional paid in capital   349,796 
Carrying value - 279,837 Series A-1 Warrants exchanged - equity classified   1,879,532 
Carrying Value Series Z Warrants issued upon exchange of Series A-1 Warrants  $2,229,328 

 

The March 15, 2018 Exchange Date estimated fair value of $895,478 of the 1,399,185 Series Z Warrants issued upon the exchange of 279,837 Series A-1 Warrants was computed using a Black-Scholes valuation model, using the following assumptions:

 

Fair Value Assumptions  March 15, 2018 
Series Z Warrants - issued upon exchange of Series A-1 Warrants  Exchange Date 
Aggregate fair value  $895,478 
Series Z Warrants issued upon exchange of Series A-1 Warrants   1,399,185 
Exercise price per share - Series Z Warrant  $3.00 
Value of common stock  $1.70 
Expected term (years)   6.1 
Volatility   59%
Risk free rate   2.7%
Dividend yield   0%

 

The March 15, 2018 Exchange Date estimated fair value of $545,682 of the 279,837 Series A-1 Warrants exchanged for 1,399,185 Series Z Warrants was computed using a Black-Scholes valuation model, using the following assumptions:

 

Fair Value Assumptions  March 15, 2018 
Series A-1 Warrants - exchanged for Series Z Warrants  Exchange Date 
Aggregate fair value  $545,682 
Series A-1 Warrants exchanged for Series Z Warrants   279,837 
Exercise price per share - Series A-1 Warrant  $6.67 
Series W Warrants   1,399,185 
Exercise price per share - Series W Warrant   5.00 
Value of common stock  $1.70 
Expected term (years)   3.9 
Volatility   67%
Risk free rate   2.5%
Dividend yield   0%

 

27
 

 

Note 11 — Financial Instruments Fair Value Measurements (continued)

 

Series A Exchange Offer - November 17, 2017

 

As noted above, a total of 422,838 shares of Series A Convertible Preferred Stock and 422,838 Series A Warrants were issued in the Series A Preferred Stock private placement. On November 17, 2017 (“November 17, 2017 Exchange Date”), the Company completed an exchange offer initiated on October 20, 2017 to all 28 holders of the Series A Convertible Preferred Stock and Series A Warrants - to exchange one share Series A Convertible Preferred Stock for 1.5 shares of Series A-1 Convertible Preferred Stock, and, one Series A Warrant for one Series A-1 Warrant (“Series A Exchange Offer”) - resulting in 154,837 shares of Series A Convertible Preferred Stock exchanged for 232,259 shares of Series A-1 Convertible Preferred Stock, and 154,837 Series A Warrants exchanged for 154,837 Series A-1 Warrants, by 13 holders on the November 17, 2017 Exchange Date.

 

The Series A Exchange Offer resulted in the extinguishment of: 154,837 shares of Series A Convertible Preferred Stock, the corresponding (bifurcated) conversion option derivative liability, and, 154,837 Series A Warrants, resulting from the issuance-upon-exchange of: 232,259 shares of Series A-1 Convertible Preferred Stock and 154,837 Series A-1 Warrants, each as discussed herein below.

 

Series A Exchange Offer - November 17, 2017

Series A-1 Convertible Preferred Stock Issued Upon Exchange of Series A Convertible Preferred Stock

 

The fair value of the consideration given in the form of the issue of 232,259 shares of Series A-1 Convertible Preferred Stock, with such fair value recognized as the carrying value of such issued shares of Series A-1 Convertible Preferred Stock, as compared to the extinguishment of both the carrying value of the Series A Convertible Preferred Stock and the fair value of the corresponding conversion option derivative liability, resulted in an excess of fair value of $504,007 recognized as a deemed dividend charged to accumulated deficit in the unaudited condensed consolidated balance sheet on the November 17, 2017 Exchange Date, with such deemed dividend included as a component of net loss attributable to attributable to common stockholders, summarized as follows:

 

   Series A 
Series A-1 Convertible Preferred Stock Issued  Exchange Offer 
Series A Convertible Preferred Stock and Conversion Option Derivative Liability Extinguished  November 17, 2017 
Deemed Dividend Charged to Accumulated Deficit  Exchange Date 
Fair value - 232,259 shares of Series A-1 Convertible Preferred Stock issued  $843,100 
Less: Fair value - Series A Convertible Preferred Stock conversion option derivative liability extinguished   339,093 
Less: Carrying value - 154,837 shares of Series A Convertible Preferred Stock exchanged    
Deemed dividend charged to accumulated deficit  $504,007 

 

The November 17, 2017 Exchange Date estimated fair value of $843,100 of the 232,259 shares of Series A-1 Convertible Preferred Stock issued upon the exchange of 154,837 shares of Series A Convertible Preferred Stock was computed using a combination of the present value of its cash flows using a synthetic credit rating analysis required rate of return and the Black-Scholes option pricing model, using the following assumptions:

 

Fair Value Assumptions -  November 17, 2017 
Series A-1 Convertible Preferred Stock issued upon exchange of Series A Convertible Preferred Stock  Exchange Date 
Aggregate fair value  $843,100 
Series A-1 Convertible Preferred Stock shares   232,259 
Required rate of return   27.0%
Common stock conversion factor numerator  $4.00 
Common stock conversion factor denominator  $4.00 
Value of common stock  $4.33 
Expected term (years)   6.45 
Volatility   53%
Risk free rate   2.2%
Dividend yield   0%

 

The November 17, 2017 Exchange Date estimated fair value of $339,093 of the extinguished Series A Convertible Preferred Stock conversion option derivative liability was estimated using a Monte Carlo simulation valuation model, using the Company’s common stock price and certain other Level-3 inputs to take into account the probabilities of certain events occurring over their respective life, using the following assumptions.

 

Fair Value Assumptions -  November 17, 2017 
Series A Convertible Preferred Stock Conversion Option Derivative Liability  Exchange Date 
Aggregate fair value  $339,093 
Series A Convertible Preferred Stock shares   154,837 
Value of common stock  $4.33 
Common stock exchange factor numerator  $6.00 
Common stock exchange factor denominator  $4.97 
Expected term (years)   6.45 
Volatility   53%
Risk-free interest rate   2.2%
Dividend yield   0%

 

28