NovaBay Pharmaceuticals, Inc. - Quarter Report: 2020 March (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2020

  

OR

 

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

 

For the transition period from                              to                             

 

Commission File Number: 001-33678

 

NOVABAY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	68-0454536
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

 

2000 Powell Street, Suite 1150, Emeryville, CA 94608

(Address of principal executive offices) (Zip Code)

 

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

 

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

Title of Each Class	Trading Symbol(s)	Name of Each Exchange On Which Registered
Common Stock, par value $0.01 per share	NBY	NYSE American

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒    No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒    No ☐

 

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

 

Large accelerated filer	☐	Accelerated filer	☐	Emerging growth company	☐
Non-accelerated filer	☐	Smaller reporting company	☒

 

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

 

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

 

As of May 5, 2020, there were 28,810,563 shares of the registrant’s common stock outstanding. 

 

 

NOVABAY PHARMACEUTICALS, INC.

 

TABLE OF CONTENTS

 

  

PART I
FINANCIAL INFORMATION
Item 1.		Financial Statements	3
	1.	Condensed Consolidated Balance Sheets: March 31, 2020 (unaudited) and December 31, 2019	3
	2.	Condensed Consolidated Statements of Operations and Comprehensive Loss: Three months ended March 31, 2020 and 2019 (unaudited)	4
	3.	Condensed Consolidated Statements of Cash Flows: Three months ended March 31, 2020 and 2019 (unaudited)	5
	4.	Condensed Consolidated Statements of Stockholders’ (Deficit) Equity: Three months ended March 31, 2020 and 2019 (unaudited)	7
	5.	Notes to Condensed Consolidated Financial Statements (unaudited)	8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	35
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.		Controls and Procedures	43
PART II
OTHER INFORMATION
Item 1A.		Risk Factors	43
Item 5.		Other Information	58
Item 6.		Exhibits	58
SIGNATURES			60
EXHIBIT INDEX			58

 

 

 

		March 31,				December 31,
		2020				2019
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	5,708			$	6,937
Accounts receivable, net of allowance for doubtful accounts ($50 and $51 at March 31, 2020 and December 31, 2019, respectively)			952				1,066
Inventory, net of allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments ($230 and $247 at March 31, 2020 and December 31, 2019, respectively)			552				492
Prepaid expenses and other current assets			662				886
Total current assets			7,874				9,381
Operating lease right-of-use assets			1,028				1,252
Property and equipment, net			97				110
Other assets			476				477
TOTAL ASSETS		$	9,475			$	11,220
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Liabilities:
Current liabilities:
Accounts payable		$	602			$	331
Accrued liabilities			1,326				1,778
Deferred revenue			559				—
Operating lease liabilities			774				930
Notes payable, related party			1,250				1,202
Convertible note			954				1,409
Embedded derivative liability			1				3
Warrant liability			17				34
Total current liabilities			5,483				5,687
Operating lease liabilities-non-current			406				505
Warrant liability			3,935				4,055
Total liabilities			9,824				10,247
Stockholders' (deficit) equity:
Preferred stock: 5,000 shares authorized; none issued and outstanding at March 31, 2020 and December 31, 2019			—				—
Common stock, $0.01 par value; 50,000 shares authorized; 28,239 and 27,938 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively			282				279
Additional paid-in capital			125,975				125,718
Accumulated deficit			(126,606	)			(125,024	)
Total stockholders' (deficit) equity			(349	)			973
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY		$	9,475			$	11,220

 

		Three Months Ended March 31,
		2020				2019
Sales:
Product revenue, net		$	1,892			$	1,450
Other revenue, net			—				41
Total sales, net			1,892				1,491
Product cost of goods sold			581				341
Gross profit			1,311				1,150
Operating expenses:
Research and development			9				85
Sales and marketing			1,560				3,531
General and administrative			1,277				1,605
Total operating expenses			2,846				5,221
Operating loss			(1,535	)			(4,071	)
Non-cash gain (loss) on changes in fair value of warrant liability			137				(57	)
Non-cash gain on changes in fair value of embedded derivative liability			2				-
Other expense, net			(186	)			(60	)
Loss before provision for income taxes			(1,582	)			(4,188	)
Provision for income taxes			—				(1	)
Net loss and comprehensive loss		$	(1,582	)		$	(4,189	)
Net loss per share attributable to common stockholders (basic and diluted)		$	(0.06	)		$	(0.25	)
Weighted-average shares of common stock used in computing net loss per share attributable to common stockholders (basic and diluted)			27,978				17,093

 

		Three Months Ended March 31,
		2020				2019
Operating activities:
Net loss		$	(1,582	)		$	(4,189	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			14				17
Impairment of operating lease right-of-use assets			—				125
Stock-based compensation expense for options and stock issued to employees and directors			45				107
Stock-based compensation expense for options and stock issued to non-employees			12				7
Issuance of RSUs to employees			2				10
Non-cash (gain) loss on changes in fair value of warrant liability			(137	)			57
Non-cash gain on changes in fair value of embedded derivative liability			(2	)			—
Interest expense related to amortization of debt issuance and debt discount			105				20
Interest expense related to amortization of debt issuance related to related party notes payable			1				5
Changes in operating assets and liabilities:
Accounts receivable			113				954
Inventory			(59	)			(21	)
Prepaid expenses and other current assets			223				214
Operating lease right-of-use assets			224				244
Other assets			1				10
Accounts payable and accrued liabilities			(175	)			(521	)
Operating lease liabilities			(252	)			(256	)
Deferred revenue			559				(41	)
Related party notes payable			47				34
Long-term obligations			(4	)			3
Net cash used in operating activities			(865	)			(3,221	)
Investing activities:
Purchases of property and equipment			—				(14	)
Net cash used in investing activities			—				(14	)
Financing activities:
Proceeds from issuance of related party notes payable			—				1,000
Proceeds from stock options & RSUs sold to cover taxes			—				4
Proceeds from exercise of warrants			201				—
Proceeds from convertible notes, net of discount			—				2,000
Payment on the convertible note			(565	)			—
Debt issuance cost			—				(20	)
Net cash (used in) provided by financing activities			(364	)			2,984
Net decrease in cash, cash equivalents, and restricted cash			(1,229	)			(251	)
Cash, cash equivalents and restricted cash, beginning of year			7,412				3,658
Cash, cash equivalents and restricted cash, end of year		$	6,183			$	3,407

		Three Months Ended March 31,
		2020				2019
Supplemental disclosure of cash flow information:
Interest paid		$	35			$	—

		Three Months Ended March 31,
		2020				2019
Supplemental disclosure of non-cash information:
Cumulative effect of adoption of ASU 2017-11		$	—			$	56
Addition of operating lease, right-of-use asset		$	—			$	2,473
Fixed asset purchases, included in accounts payable and accrued liabilities		$	—			$	(5	)

 

																		Total
										Additional								Stockholders'
		Common Stock								Paid-In				Accumulated				Equity
2020		Shares				Amount				Capital				Deficit				(Deficit)
Balance at December 31, 2019			27,938			$	279			$	125,718			$	(125,024	)		$	973
Net loss			—				—				—				(1,582	)			(1,582	)
Issuance of common stock in connection with exercise of warrants, net of issuance cost			299				3				198				—				201
Vesting of employee restricted stock awards			2				—				2				—				2
Stock-based compensation expense related to employee and director stock options			—				—				45				—				45
Stock-based compensation expense related to non-employee and director stock options			—				—				12				—				12
Balance at March 31, 2020			28,239			$	282			$	125,975			$	(126,606	)		$	(349	)

		Common Stock								Additional Paid-In				Accumulated				Total Stockholders'
2019		Shares				Amount				Capital				Deficit				Equity
Balance at December 31, 2018			17,089			$	171			$	119,764			$	(114,981	)		$	4,954
Net loss			—				—				—				(4,189	)			(4,189	)
Reclassification of Warrant Liability to Equity			—				—				412				(356	)			56
Vesting of employee restricted stock awards			6				—				10				—				10
Stock-based compensation expense related to employee and director stock options			—				—				107				—				107
Stock-based compensation expense related to non-employee and director stock options			—				—				7				—				7
Debt discount associated with the convertible note – beneficial conversion feature			—				—				184				—				184
Balance at March 31, 2019			17,095			$	171			$	120,484			$	(119,526	)		$	1,129

 

NOTE 1. ORGANIZATION

  

NovaBay Pharmaceuticals, Inc. (the “Company”) is a biopharmaceutical company focusing on commercializing and developing its non-antibiotic anti-infective products to address the unmet therapeutic needs of the global, topical anti-infective market with its two distinct product categories: the NEUTROX® family of products and the AGANOCIDE® compounds. The Neutrox family of products includes AVENOVA® for the eye care market, NEUTROPHASE® for the wound care market, and CELLERX® for the aesthetic dermatology market. The Aganocide compounds have target applications in the dermatology and urology markets but are still in a clinical phase and not yet commercially available.

 

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

 

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

  

Liquidity

 

Based primarily on the funds available at March 31, 2020, the Company believes these resources will be sufficient to fund its operations into the fourth quarter of 2020. Subsequent to March 31, 2020, we (1) entered into an At the Market Offering Agreement with Ladenburg (the “ATM Program”), to allow the Company to raise up to approximately $4.3 million in the future through sales of our common stock through Ladenburg as sales agent, subject to the terms of the ATM Program and certain restrictions, including, but not limited to, general stock market conditions and our specific stock price, and (2) have been notified that we will receive an approximately $900 thousand PPP Loan to, among other things, support the employment of our Avenova salesforce, which has been greatly restricted in its ability to solicit eye care professionals due to the COVID-19 “stay at home” orders.  We have not, as of May 7, 2020, received any funds from the ATM Program, or been able to request any sales of our stock under the ATM Program while we are in a trading blackout.  Both the ATM Program and PPP Loan have certain limitations and risk as outlined in our risk factor “There is uncertainty about our ability to continue as a going concern” in Part II, Item 1A of this report. 

 

The Company has sustained operating losses for the majority of its corporate history and expects that its 2020 expenses will exceed its 2020 revenues, as the Company continues to re-invest in its Avenova commercialization efforts. The Company expects to continue incurring operating losses and negative cash flows until revenues reach a level sufficient to support ongoing growth and operations. Accordingly, the Company’s planned operations raise substantial doubt about its ability to continue as a going concern. The Company’s liquidity needs will be largely determined by the success of operations in regard to the commercialization of Avenova. The Company also may consider other plans to fund operations including: (1) out-licensing rights to certain of its products or product candidates, pursuant to which the Company would receive cash milestones or an upfront fee; (2) raising additional capital through debt and equity financings or from other sources; (3) reducing spending on one or more of its sales and marketing programs; (4) entering into license agreements to sell new product and/or (5) restructuring operations to change its overhead structure. The Company may issue securities, including common stock and warrants through private placement transactions or registered public offerings, which would require the filing of a Form S-1 or Form S-3 registration statement with the Securities and Exchange Commission (“SEC”). In the absence of the Company’s completion of one or more of such transactions, there will be substantial doubt about the Company's ability to continue as a going concern within one year after the date these unaudited financial statements are issued, and the Company will be required to scale back or terminate operations and/or seek protection under applicable bankruptcy laws. The accompanying unaudited financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from uncertainty related to its ability to continue as a going concern.

 

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

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

 

Use of Estimates

 

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

 

 

Unaudited Interim Financial Information

 

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

 

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

 

Cash, Cash Equivalents, and Restricted Cash

 

The Company considers all highly-liquid instruments with a stated maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates fair value. As of March 31, 2020 and December 31, 2019, the Company’s cash and cash equivalents were held in a highly-rated, major financial institution in the United States.

  

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

 

 

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

 

 

Concentrations of Credit Risk and Major Partners

 

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

  

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

  

During the three months ended March 31, 2020, revenues were derived primarily from sales of Avenova directly to consumers through Amazon.com, directly to doctors through the Company’s webstore, and to pharmacies via three major distribution partners and specialty pharmacies. Revenues were also generated from sales of KN95 masks through the Company’s webstore. During the three months ended March 31, 2019, revenues were derived primarily from sales of Avenova directly to three major distribution partners and to doctors through the Company’s webstore.

 

During the three months ended March 31, 2020 and 2019, revenues from our major distribution or collaboration partners greater than 10% were as follows:

 

 

   *Not greater than 10%

 

 

As of March 31, 2020 and December 31, 2019, accounts receivable from our major distribution partners greater than 10% were as follows:

 

 

The Company relies on two contract sole source manufacturers to produce its finished goods. The Company does not have any manufacturing facilities and intends to continue to rely on third parties for the supply of finished goods. Third party manufacturers may not be able to meet the Company’s needs with respect to timing, quantity or quality. In particular, it is possible that we may suffer from unexpected supply chain delays in light of the worldwide COVID-19 pandemic.

  

Fair Value of Financial Assets and Liabilities

 

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

 

The Secured Convertible Promissory Note issued on March 26, 2019 (the “Convertible Note”) is carried at cost, which management believes approximates fair value. Additionally, the derivative liability related to certain embedded features contained within the Convertible Note is carried at fair value. The warrant liability is also carried at fair value.

 

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

 

Level 1 – quoted prices in active markets for identical assets or liabilities;

Level 2 – quoted prices for similar assets and liabilities in active markets or inputs that are observable; and

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

 

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

 

Allowance for Doubtful Accounts

 

The Company charges bad debt expense and records an allowance for doubtful accounts when management believes it to be unlikely that specific invoices will be collected. Management identifies amounts due that are in dispute and it believes are unlikely to be collected. At March 31, 2020 and December 31, 2019, management reserved $50 thousand and $51 thousand, respectively, primarily based on specific amounts that were in dispute or were over 120 days past due.

 

Inventory

 

Inventory is comprised of (1) raw materials and supplies, such as bottles, masks, packaging materials, labels, boxes and pumps; (2) goods in progress, which are normally unlabeled bottles; and (3) finished goods. We utilize contract manufacturers to produce our products and the cost associated with manufacturing is included in inventory. At March 31, 2020 and December 31, 2019, management had recorded an allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments of $230 thousand and $247 thousand, respectively.

 

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

 

 

Property and Equipment

 

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

 

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

 

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

 

The Company accounts for long-lived assets and operating lease right-of-use assets in accordance with ASC 360, Property, Plant and Equipment, which requires that companies consider whether events or changes in facts and circumstances, both internally and externally, may indicate that an impairment of long-lived assets held for use or right-of-use assets are present. Management periodically evaluates the carrying value of long-lived assets and right-of-use assets. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the assets are written down to their estimated fair values and the loss is recognized in the condensed consolidated statements of operations and comprehensive loss. During the first quarter of 2019, in connection with the restructuring of its U.S. sales force, the Company reviewed its fleet leases for impairment and recorded an impairment charge of $125 thousand. There was no such impairment charge during the first quarter of 2020.

 

Leases

 

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

 

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

 

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

 

Comprehensive Income (Loss)

 

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

 

Revenue Recognition

 

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

 

Revenue generated through the Company’s webstore is recognized upon shipment to the customer. We ship high volumes of packages through multiple third-party carriers. Shipping and handling costs are expensed as fulfillment costs as incurred and included in cost of goods sold in the condensed consolidated statements of operations and comprehensive loss. We present revenue net of sales taxes and refunds.

 

Special bulk orders of KN95 disposable air filter masks are shipped directly to the customer out of a manufacturer in China. Revenue is recognized when control of the product passes to the customer, which is upon delivery of the KN95 masks to the customer. As such, customer orders are recorded as deferred revenue prior to delivery of products.

 

 

Revenue generated through Amazon.com is recognized upon orders fulfilled by Amazon.com, which generally occurs upon delivery of the related products to a third-party carrier or, in the case of an Amazon delivery, to the customer. We present revenue net of commissions and any related fulfillment and shipping fees charged by Amazon.com. Fees paid to Amazon.com for promoting our product are expensed as incurred, and are included in sales and marketing expenses within the operating expenses in the condensed consolidated statements of operations and comprehensive loss.

 

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

 

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

 

Performance Obligations

 

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

 

●

Product supply

●

Exclusive distribution rights in the product territory

●

Regulatory submission and approval services

●

Development services

●

Sample supply, free of charge

●

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

 

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

 

Transaction Price

 

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

 

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

 

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

 

 

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

  

Allocation of Consideration

 

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

 

Timing of Recognition

 

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

 

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

 

Cost of Goods Sold

 

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

  

Research and Development Costs

 

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

 

Patent Costs

 

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

 

 

Stock-Based Compensation

 

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

  

Income Taxes

 

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

 

Common Stock Warrant Liability

 

The Company accounts for the issuance of common stock purchase warrants issued in connection with its equity offerings in accordance with the provisions of ASC 815, Derivatives and Hedging. The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). For warrants that are classified as liabilities, the Company records the fair value of the warrants at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the condensed consolidated statements of operations and comprehensive loss. The fair values of these warrants have been determined using the Black-Scholes option pricing model or the Binomial Lattice (“Lattice”) valuation model where deemed appropriate. These values are subject to a significant degree of the Company’s judgment.

 

Net Loss per Share

 

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

 

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

 

During the three months ended March 31, 2020 and 2019, there was no difference between basic and diluted EPS in each period due to the Company’s net loss.

   

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

 

 

 

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

 

 

Shares underlying the Convertible Note were excluded from EPS calculation as the Company intends to settle the Convertible Note in cash in lieu of stock pursuant to the August SPA. See Note 12, “Stockholders’ Equity (Deficit)” for further discussion of the terms of the August SPA.

 

Recent Accounting Pronouncements

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard removes, modifies, and adds certain disclosure requirements. The Company adopted the new standard effective January 1, 2020 and the adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. ASU 2016-13 is effective for the Company for annual and interim reporting periods beginning January 1, 2023. The Company will adopt the new standard effective January 1, 2023. We are currently evaluating the impact of the new guidance on our condensed consolidated financial statements.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes. This guidance will be effective for us in the first quarter of 2021 on a prospective basis. We are currently evaluating the impact of the new guidance on our condensed consolidated financial statements.

 

NOTE 3. FAIR VALUE MEASUREMENTS

 

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

 

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

 

As of March 31, 2020, the Company’s warrants consist of warrants to purchase the Company’s common stock issued in October 2015, June 2019 and August 2019, out of which the warrants issued in October 2015 and August 2019 are classified as liabilities. The June 2019 warrants are considered to be indexed to the Company’s stock and are therefore classified as equity. 35,107 July 2011 Warrants (as defined below) and 7,419 March 2015 Warrants (as defined below) expired unexercised during the three months ended March 31, 2020. As July 2011 Warrants were classified as liabilities prior to expiration, the expiration of the warrants resulted in a decrease of $15 thousand in warrant liability. The Company's warrant liability is classified within Level 3 of the fair value hierarchy because the value is calculated using significant judgment based on the Company’s own assumptions in the valuation of this liability. The Company determined the fair value of the warrant liability using the Black-Scholes valuation method or the Lattice valuation model where deemed appropriate. See Note 11, “Warrant Liability” for further discussion of the calculation of the fair value of the warrant liability.

 

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

 

 

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2020:

 

 

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

 

 

 

The following is a reconciliation of the beginning and ending balances for the liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2020:

 

 

 

NOTE 4. PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of the following:

 

 

 

NOTE 5. INVENTORY   

 

Inventory consisted of the following:

 

 

 

 

NOTE 6. PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

 

Depreciation and amortization expense was $14 thousand and $17 thousand for the three months ended March 31, 2020 and 2019, respectively.

 

NOTE 7. ACCRUED LIABILITIES

 

Accrued liabilities consisted of the following:

 

 

 

NOTE 8. COMMITMENTS AND CONTINGENCIES 

 

Directors and Officers Indemnification

 

As permitted under Delaware law and in accordance with its bylaws, the Company indemnifies its officers and directors for certain events or occurrences while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and may enable it to recover a portion of any future payments. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, it has not recorded any liabilities for these agreements as of March 31, 2020. 

 

In the normal course of business, the Company provides indemnification of varying scope under its agreements with other companies, typically its clinical research organizations, investigators, clinical sites, suppliers and others. Pursuant to these agreements, it generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified parties in connection with the use or testing of its products or product candidates or with any U.S. patent or any copyright or other intellectual property infringement claims by any third party with respect to its products. The term of these indemnification agreements is generally perpetual. The potential future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, costs related to these indemnification provisions have been immaterial. The Company also maintains various liability insurance policies that limit its exposure. As a result, it believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of March 31, 2020. 

 

 

Legal Matters

 

From time to time, the Company may be involved in various legal proceedings arising in the ordinary course of business. On July 29, 2019, Mr. John McGovern, the Company’s former Interim President & Chief Executive Officer and Chief Financial Officer, submitted a demand for arbitration seeking severance in the amount of $370,000 as well as additional damages in connection with his separation from service with the Company. The Company does not believe the claims asserted by Mr. McGovern have any merit, and the Company intends to defend against all such claims. As of March 31, 2020, there are no other matters that, in the opinion of management, would ultimately result in liability that would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

Leases

 

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

 

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

 

In addition to the facility leases, the Company has leased 54 vehicles under a master fleet lease agreement. Each lease is for a period of 36 months, which commenced upon the delivery of the vehicle during the first quarter of 2017. During the first quarter of 2019, in connection with the restructuring of its U.S. sales force, the Company reviewed its fleet leases for impairment. The Company estimated fair value based on the lowest level of identifiable estimated future cash flows and recorded an impairment charge of $125 thousand, which is included in sales and marketing expenses within the operating expenses in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2019. During the fourth quarter of 2019, the Company early terminated the lease agreement related to the idled vehicles, and had 15 leased vehicles as of December 31, 2019. The lease agreement expired in the first quarter of 2020, and, as of March 31, 2020, the Company no longer has any leased vehicles.

 

Additionally, the Company has an operating lease for 2 copiers which will expire in October 2022. The monthly lease payment for the copiers is not material.

 

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

 

 

The components of lease expense for the three months ended March 31, 2020 and 2019 were as follows (in thousands except lease term and discount rate):

 

 

Future lease payments under non-cancelable leases as of March 31, 2020 were as follows (in thousands):

 

 

Future lease payments to be received under non-cancelable leases as of March 31, 2020 were as follows (in thousands):

 

 

 

 

NOTE 9. RELATED PARTY NOTES PAYABLE

 

On February 27, 2019, the Company issued a $1.0 million promissory note payable to Pioneer Pharma (Hong Kong) Company Ltd. (“Pioneer Hong Kong”), which was amended on June 25, 2019 (the “Promissory Note”). The Promissory Note currently bears an interest payment of $300 thousand (initially $150 thousand) and is payable in full upon the Company’s next financing with Pioneer Hong Kong and in no event after July 1, 2020 (an extension per the June amendment from the initial maturity date of July 27, 2019). The transaction was facilitated by China Kington Asset Management Co. Ltd. (“China Kington”) which has a perfected security interest in all tangible and intangible assets of the Company. In connection with the Promissory Note, the Company paid China Kington a 2% fee for brokering the transaction and entered into a consulting agreement with China Kington for a term of one year, which expired on March 1, 2020. Bob Wu, acting in a dual role as a member of the Company’s Board of Directors and as principal of China Kington, was paid $100 thousand pursuant to such consulting agreement. Upon the expiration of the consulting agreement, the parties entered into a standard consulting agreement, in which no cash compensation will be paid. Debt issuance costs associated with the issuance of the Promissory Note of $20 thousand was recognized and recorded as an offset to the related party notes payable in the consolidated balance sheet. The debt issuance cost is being amortized to interest expense using the effective interest rate method over the term of the Promissory Note, assuming that the Promissory Note will be fully paid on July 1, 2020. The Company established a new effective interest rate based on the carrying value of the original debt and the revised cash flows.

 

The interest expense recognized, including amortization of the issuance costs, was $48 thousand and $39 thousand during the three months ended March 31, 2020 and 2019, respectively.

 

 

The Promissory Note is presented as follows as of March 31, 2020:

 

 

 

NOTE 10. CONVERTIBLE NOTE

 

On March 26, 2019 (the “Closing Date”), the Company entered into a Securities Purchase Agreement with Iliad Research and Trading, L.P. (the “Lender”), pursuant to which the Company issued a Secured Convertible Promissory Note (the “Convertible Note”) to the Lender dated as of the Closing Date. The Convertible Note has an original principal amount of $2.2 million, bears interest at a rate of 10% per annum and will mature on September 26, 2020, unless earlier paid, redeemed or converted in accordance with its terms. The Company received net proceeds of $2.0 million after deducting an original issue discount of $200 thousand and debt issuance cost of Lender’s transaction fees of $15 thousand. The Company recognized an additional $182 thousand of debt issuance costs associated with the issuance of the Convertible Note.

 

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

 

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

 

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

 

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

 

The Company’s prepayment terms represent an embedded call option, the Lender’s share redemption terms represent an embedded put option and certain events of default represent embedded derivatives, each of which require bifurcation. A single derivative comprising all bifurcatable features was measured at fair value using a Monte Carlo simulation model. The fair value of the embedded derivative at issuance of the Convertible Note on March 26, 2019 was $0.4 million. The key assumptions used to value the combined embedded derivative upon issuance at March 26, 2019 were as follows:

 

 

 

The key assumptions used to value the combined embedded derivative as of March 31, 2020 and December 31, 2019 were as follows:

 

  

The aggregate $627 thousand discount, including the original issue discount, and the aggregate $197 thousand of debt issuance costs, including the Company’s issuance costs and payment for the Lender’s transaction fees, were recorded at issuance, and were classified as an offset to the Convertible Note on the consolidated balance sheet. The Convertible Note is presented as follows as of March 31, 2020:

 

 

The discount and debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Convertible Note, assuming that the Convertible Note will be redeemed at the maximum $200 thousand per month beginning in September 2019. During the three months ended March 31, 2020, the effective interest rate on the Convertible Note was 54% and interest expense recognized, including amortization of the debt discount and issuance costs, was $140 thousand. During the three months ended March 31, 2019, the effective interest rate on the Convertible Note was 64% and interest expense recognized, including amortization of the debt discount and issuance costs, was $24 thousand.

 

On August 8, 2019, the Company entered into a securities purchase agreement (the “August SPA”) with certain domestic investors for the sale and issuance of 4,198,566 shares of common stock in a registered direct offering and 4,198,566 warrants exercisable for 4,198,566 shares of common stock in a simultaneous private placement at an offering price of $1.00 per share. The August SPA prohibits the Company from redeeming in common stock or common stock equivalents in satisfaction of the Promissory Note with the Lender and may only issue common stock in satisfaction of the Promissory Note if the stock price equals or exceeds $2.00. See Note 12, “Stockholders’ Equity (Deficit)” for further discussion of the terms of the August SPA.

 

The Lender started redeeming $200 thousand of the Convertible Note every month since September 27, 2019. During the three months ended March 31, 2020, the Company had repaid a total of $600 thousand in cash, $565 thousand of which was applied against the outstanding balance of the convertible note. As of March 31, 2020, the Company's contractual maturity of the principal balance of the Convertible Note was as follows:

 

 

 

NOTE 11. WARRANT LIABILITY  

 

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

 

 

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

 

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

 

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

 

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

 

On March 6, 2020, 35,107 July 2011 Warrants and 7,419 March 2015 Warrants expired without being exercised. As of March 31, 2020, there were no July 2011 Warrants or March 2015 Warrants outstanding.

 

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

 

 

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

 

 

The key assumptions used to value the October 2015 warrants as of March 31, 2020 and December 31, 2019 were as follows:

 

 

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

 

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

 

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

 

The 2019 Domestic Warrants are exercisable six months after the date of issuance and will expire on February 13, 2025, with an exercise price of $1.15. The terms of the 2019 Domestic Warrants require registered shares to be delivered upon each warrant’s exercise and also require possible cash payments to the warrant holders (in lieu of the warrant’s exercise) upon specified fundamental transactions involving the Company’s common stock, such as an acquisition of the Company. The 2019 Domestic Warrants contain a provision according to which the warrant holder would have the option to receive cash, equal to the Black Scholes fair value of the remaining unexercised portion of the warrant, as cash settlement in the event that there is a fundamental transaction (contractually defined to include various merger, acquisition or stock transfer activities). Due to this provision, ASC 480 requires the 2019 Domestic Warrants be classified as liabilities. The fair values of these warrants have been determined using the Black-Scholes option pricing model, and the changes in the fair value are recorded in the condensed consolidated statement of operations and comprehensive loss. The fair value of the 2019 Domestic Warrants at issuance on August 13, 2019 was $3.1 million. 

 

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

 

 

 

The key assumptions used to value the 2019 Domestic Warrants as of March 31, 2020 and December 31, 2019 were as follows:

 

 

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

 

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

 

 

The key assumptions used to value the 2019 Ladenburg Warrants as of March 31, 2020 and December 31, 2019 were as follows:

 

 

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

 

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

 

 

 

The key assumptions used to value the 2019 Foreign Warrants as of March 31, 2020 and December 31, 2019 were as follows:

 

 

The number of shares and fair value of the outstanding warrant liability as of March 31, 2020 were as follows (in thousands):

 

 

 

NOTE 12. STOCKHOLDERS’ EQUITY (DEFICIT)

 

Preferred Stock

 

Under the Company’s amended articles of incorporation, the Company is authorized to issue up to 5,000,000 shares of preferred stock in such series and with such rights and preferences as may be approved by the Board of Directors. As of March 31, 2020 and December 31, 2019, there were no shares of preferred stock outstanding.

 

On August 8, 2019, the Company entered into a securities purchase agreement for the sale of (i) 2,700,000 shares of the Series A Preferred Stock that automatically converted into 2,700,000 shares of common stock, at a ratio of 1:1, upon the approval of the Company’s stockholders, which occurred on October 9, 2019, and (ii) 2,700,000 common stock purchase warrants exercisable for 2,700,000 shares of Common Stock.

 

As the conversion trigger was dependent upon stockholder approval which is considered to be outside the control of the Company, the Series A Preferred Stock was considered to be contingently redeemable and as a result, was classified as mezzanine equity in the Company’s interim balance sheet as of September 30, 2019. Upon conversion of the Series A Preferred Stock into shares of the Company’s common stock in October 2019, it is classified as equity in the Company’s balance sheet as of December 31, 2019.

 

The Company applied the fair value allocation methodology for allocating the proceeds of $2.7 million received from the Series A financing. The Company first allocated $2.0 million based on the fair value of the warrants as of the issuance date, with residual amount being allocated to the Series A Preferred Stock. See Note 11, “Warrant Liability” for further discussion of the key assumptions used to value the warrants.

  

 

China Kington served as placement agent in exchange for a commission equal to six percent (6%) of the gross proceeds, totaling $162 thousand. The Company incurred additional issuance costs of $33 thousand. The Company allocated $93 thousand to the warrant liability, which was expensed during the period and $102 thousand was recorded as a reduction to the Series A Preferred Stock.

 

On October 9, 2019, the Company held a special meeting of stockholders (the “Special Meeting”), at which the Company’s stockholders approved (i) the conversion of 2,700,000 shares of the Series A Preferred Stock into 2,700,000 shares of the Company’s common stock, and (ii) the 2,700,000 shares of Company common stock that may be issued upon the exercise of the 2,700,000 2019 Foreign Warrants, in accordance with the stockholder approval requirements of NYSE American LLC Company Guide Section 713(a). A beneficial conversion feature of $800 thousand was recorded as a discount to the preferred stock and an increase to additional paid in capital. Because the Series A Preferred Stock was perpetual, in October 2019, the Company fully amortized the discount related to the beneficial conversion feature on the deemed dividend in the consolidated statement of operations and comprehensive loss, which is reflected in the results for the year ended December 31, 2019.

 

Common Stock

 

During the first quarter of 2018, the Company entered into a share purchase agreement with OP Financial Investments Limited for the sale of an aggregate of 1,700,000 shares of the Company’s common stock, par value $0.01 per share, for an aggregate purchase price of $5.984 million (the “OP Private Placement”). The OP Private Placement closed on February 8, 2018. OP Financial Investments Limited is an investment firm based in Hong Kong focused on cross-border investment opportunities and listed on the Hong Kong Stock Exchange. China Kington served as placement agent in exchange for a commission equal to six percent (6%) of the gross proceeds, totaling $359 thousand. The Company also paid $34 thousand to NYSE American for the listing of the additional shares.

 

On March 29, 2019, the Company entered into a Common Stock Purchase Agreement with Triton Funds LP, a Delaware limited partnership (“Triton”), pursuant to which the Company had the right to sell up to $3.0 million of shares of common stock of the Company at a purchase price equal to 90% of the lowest trading price of the common stock of the Company for the five business days prior to the applicable closing date. The Company also entered into a Registration Rights Agreement on March 29, 2019 with Triton, pursuant to which the Company registered such shares for resale by Triton on a registration statement on Form S-3 filed with the SEC on April 1, 2019 and declared effective on April 12, 2019. In connection with the transaction with Triton Funds LP, the Company entered into a Letter Agreement with Triton Funds LLC, an affiliate of Triton, pursuant to which the Company issued 150,000 shares of common stock to Triton Funds LLC. During the second quarter of 2019, the Company issued to Triton Funds LP an aggregate of 1,747,312 shares of the Company’s common stock, par value $0.01 per share, for an aggregate purchase price of $360 thousand. The Company also incurred and paid other offering costs of $122 thousand. On September 5, 2019, the Company received an additional $288 thousand in connection with the financing and recorded the amount in additional paid-in capital from issuance of common stock. No additional shares were issued related to the receipt of $288 thousand. The Common Stock Purchase Agreement with Triton Funds LP expired as of December 31, 2019 and the remaining registered but unsold shares were deregistered on February 1, 2020.

 

On June 26, 2019, the Company entered into a private placement to sell 1,371,427 shares of Company common stock and warrants to purchase an additional 1,371,427 shares of Company common stock for an aggregate subscription price of $2.4 million to three accredited investors including Messrs. Xiao Rui Liu, Hai Dong Pang and Ping Huang, each of whom subscribed for $1.0 million, $0.4 million and $1.0 million, respectively. China Kington served as placement agent in exchange for a commission equal to six percent (6%) of the gross proceeds, totaling $144,000. The Company also incurred and paid other offering costs of $27 thousand.

 

On August 8, 2019, the Company entered into the August SPA for the sale and issuance of 4,198,566 shares of common stock at an offering price of $1.00 per share. In connection with the August SPA, the Company issued 4,198,566 warrants to purchase 4,198,566 shares of Company common stock with an exercise price of $1.15. Ladenburg Thalmann & Co. Inc. (“Placement Agent”) served as placement agent for the transaction in exchange for a commission representing six percent (6%) of the gross proceeds, totaling $252 thousand, and the issuance of the 2019 Ladenburg Warrants to purchase up to 167,942 shares of the common stock with an exercise price of $1.25. In addition, the Company reimbursed the Placement Agent $60 thousand for certain expenses. The Company also incurred and paid other offering costs of $312 thousand. The August SPA limits the Company’s ability to issue new common stock or common stock equivalents for a period of one year (six months if it is an “at the market” offering with the Placement Agent) until the daily volume weighted average price of the Company’s common stock equals or exceeds $2.00 for a period of 10 consecutive days. The Company is prohibited from redeeming in common stock or common stock equivalents in satisfaction of the Promissory Note with Iliad Research & Trading, L.P. and may only issue common stock in satisfaction of the Promissory Note if the stock price equals or exceeds $2.00. See Note 10, “Convertible Note”, for detailed information related to the Convertible Note.

 

The Company applied the fair value allocation methodology for allocating the proceeds of $4.2 million received from the financing. The Company first allocated $3.1 million based on the fair value of the 2019 Domestic Warrants as of the issuance date, with the residual amount being allocated to the common stock. See Note 11, “Warrant Liability” for further discussion of the key assumptions used to value the warrants. 

 

 

In connection with the financing, the Company incurred issuance cost of $488 thousand of which $233 thousand was allocated to the warrant liability and expensed during the period and $255 thousand was recorded as a reduction to additional paid-in capital from the issuance of common stock. As the 2019 Ladenburg Warrants were accounted for as a stock issuance cost, $59 thousand was allocated to the warrant liability and expensed during the period and $65 thousand was recorded as a reduction to additional paid-in capital from the issuance of common stock.

 

Stock Warrants

 

In February 2016, the strike prices of the July 2011, March 2015, and October 2015 Warrants were reduced to $1.81 per share, pursuant to the price protection provisions in such warrants, because the Company sold common stock to Mr. Jian Ping Fu at that price. In May 2019, the strike price of the July 2011, March 2015, and October 2015 Warrants was further reduced to $0.2061 per share, pursuant to the price protection provisions in such warrants, because the Company sold common stock to Triton Funds LP at that price. The March 2015 Warrants were reclassified from warrant liabilities to equity upon adoption of ASU 2017-11. In March 2020, all remaining outstanding and unexercised July 2011 and March 2015 Warrants expired.

 

During the second quarter of 2019, a total of 158,400 warrants to purchase 158,400 shares of common stock were exercised related to the October 2015 Warrants resulting in gross proceeds of $33 thousand.

 

During the second quarter of 2019, a total of 133,167 warrants to purchase 133,167 shares of common stock were exercised related to the March 2015 Warrants. Out of the 133,167 warrants exercised, 70,000 warrants were exercised in a cashless transaction, resulting in 64,979 shares issued. The remaining warrants were exercised for gross proceeds of $13 thousand. 

 

In June 2019, the Company issued 1,371,427 warrants to purchase 1,371,427 shares of Company common stock in a private placement. Please see the preceding subsection, “Common Stock,” for further details regarding such private placement. Such warrants have a one (1)-year term and an exercise price of $0.87, callable by the Company if the closing price of the Company’s common stock, as reported on the NYSE American, is $1.00 or greater.

 

In July 2019, a total of 102,602 warrants to purchase 102,602 shares of common stock were exercised related to the October 2015 Warrants resulting in gross proceeds of $21 thousand.

 

In August 2019, the Company issued 4,198,566 warrants to purchase 4,198,566 shares of Company common stock in connection with a registered direct offering of common stock. Such warrants will be exercisable six months after date of issuance and will expire on February 13, 2025, with an exercise price of $1.15. The Company issued 167,942 warrants to purchase 167,942 shares of Company common stock to the Placement Agent in connection with such offering. Such warrants were exercisable immediately upon issuance and will expire on August 8, 2024, with an exercise price of $1.25. Please see the preceding subsection, “Common Stock,” for further details regarding such offering.

 

In August 2019, the Company also issued 2,700,000 warrants to purchase 2,700,000 shares of Company common stock in connection with its private placement of Series A Preferred Stock. Such warrants were exercisable upon stockholders’ approval and will expire on February 13, 2025, with an exercise price of $1.15. Please see the preceding subsection, “Preferred Stock,” for further details regarding such private placement.

 

During the first quarter of 2020, a total of 70,000 warrants to purchase 70,000 shares of common stock were exercised related to the March 2015 Warrants resulting in gross proceeds of $14 thousand.

 

On March 6, 2020, 35,107 July 2011 Warrants and 7,419 October 2015 Warrants expired unexercised. As of March 31, 2020, there was no July 2011 Warrants or March 2015 Warrants outstanding, and 38,000 October 2015 remained outstanding and will expire on October 27, 2020.

 

During the first quarter of 2020, a total of 228,571 warrants to purchase 228,571 shares of common stock were exercised related to the June 2019 Warrants resulting in gross proceeds of $199 thousand. The Company paid China Kington a fee equal to six percent (6%) of the gross proceeds, totaling $12 thousand, for brokering the transaction.

 

 

The details of all outstanding warrants as of March 31, 2020, were as follows:

 

 

 

NOTE 13. EQUITY-BASED COMPENSATION

 

Equity Compensation Plans 

 

In October 2007, the Company adopted the 2007 Omnibus Incentive Plan (the “2007 Plan”) to provide for the granting of equity awards, such as stock options, unrestricted and restricted common stock, stock units, dividend equivalent rights, and stock appreciation rights to employees, directors and outside consultants, as determined by the Board of Directors (the “Board”). At the inception of the 2007 Plan, 80,000 shares were reserved for awards under the 2007 Plan.

 

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

 

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

   

In March 2017, the Company adopted the 2017 Omnibus Incentive Plan (the “2017 Plan”), which was approved by stockholders on June 2, 2017, to provide for the granting of equity awards, such as nonqualified stock options (“NQSOs”), incentive stock options (“ISOs”), restricted stock, performance shares, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and other share-based awards to employees, directors, and consultants, as determined by the Board. The 2017 Plan will not affect awards previously granted under the 2007 Plan. The 2017 Plan allows for awards of up to 2,318,486 shares of the Company’s common stock, plus an automatic annual increase in the number of shares authorized for awards on the first day of each of the Company’s fiscal years beginning January 1, 2018 through January 1, 2027 equal to (i) 4% of the number of shares of common stock outstanding on the last day of the immediately preceding fiscal year or (ii) such lesser number of shares of common stock than provided for in Section 4(a)(i) of the 2017 Plan as determined by the Board. As of March 31, 2020, there were 3,643,878 shares available for future awards under the 2017 Plan.

 

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

 

 

Stock Option Summary 

 

The following table summarizes information about the Company’s stock options outstanding at March 31, 2020, and activity during the three-month period then ended:

 

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the closing market price of the Company’s common stock as quoted on the NYSE American as of March 31, 2020 for options that have a quoted market price in excess of the exercise price. There were no stock option awards exercised during the three months ended March 31, 2020 and 2019. The Company received no cash payments for the exercise of stock options during the three months ended March 31, 2020 and 2019.

 

As of March 31, 2020, total unrecognized compensation cost related to unvested stock options and restricted stock units was approximately $364 thousand. This amount is expected to be recognized as stock-based compensation expense in the Company’s unaudited condensed consolidated statements of operations and comprehensive loss over the remaining weighted average vesting period of 2.05 years.

 

Stock Option Awards to Employees and Directors

 

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

  

During the three months ended March 31, 2020, the Company granted options to employees and directors to purchase an aggregate of 20,000 shares of common stock. During the three months ended March 31, 2019, the Company did not grant options to purchase common stock to employees and directors.

 

The weighted-average assumptions used in determining the value of options are as follows: 

 

  

 

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

   

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

 

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

 

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

 

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

 

In addition, during the three months ended March 31, 2020 and 2019, the Company did not grant restricted stock to employees.

 

For the three months ended March 31, 2020 and 2019, the Company recognized stock-based compensation expense of $45 thousand and $107 thousand, respectively, for stock-based awards to employees and directors.  

 

Stock-Based Awards to Non-Employees

 

During the three months ended March 31, 2020 and March 31, 2019, the Company did not grant options exercisable for shares of common stock to non-employees in exchange for advisory and consulting services.

  

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

 

In addition, during the three months ended March 31, 2020 and 2019, the Company did not grant restricted stock to non-employees.

 

For the three months ended March 31, 2020 and 2019, the Company recognized stock-based compensation expense of $12 thousand and $7 thousand, respectively, related to non-employee stock option grants. 

 

Summary of Stock-Based Compensation Expense

 

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

 

 

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

 

NOTE 14. LICENSE, COLLABORATION AND DISTRIBUTION AGREEMENTS

 

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

 

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

 

 

The following table presents changes in the Company's contract assets and liabilities for the three months ended March 31, 2020 (in thousands): 

 

 

During the three months ended March 31, 2020 and 2019, the Company recognized the following revenue (in thousands):

 

 

License, Collaboration and Distribution Agreements

 

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

 

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

 

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

 

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

 

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

 

The Distribution Agreement and the Purchase Agreement expired on December 31, 2019. The Company did not renew the agreement with China Pioneer.

 

 

During the three months ended March 31, 2020, the Company earned $0 in licensing revenue related to the distribution agreement with Pioneer China. During the three months ended March 31, 2019, the Company earned $41 thousand in revenue due to the Company being relieved of contract liability as a result of changes in contract terms associated with the distribution agreement with Pioneer China.

 

During the three months ended March 31, 2020, the Company earned $173 thousand for sales of NeutroPhase to China Pioneer, which is recorded in the product sales in the unaudited condensed consolidated statements of operations and comprehensive loss. During the three months ended March 31, 2019, the Company earned $0 for sales of NeutroPhase to China Pioneer.

 

Avenova Distribution Agreements

 

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

 

During the three months ended March 31, 2020 and 2019, the Company earned $0.6 million and $1.2 million, respectively, in product revenue under the Avenova distribution agreements.

 

Under the Avenova product distribution arrangements, the Company had a contract liability balance of $0.3 million and $0.4 million at March 31, 2020 and December 31, 2019, respectively. The contract liability is included in accrued liabilities in the condensed consolidated balance sheets. The contract liability as of March 31, 2020 and December 31, 2019 included a prepayment of $0.3 million and $0.4 million rebate, respectively, that is recorded in the prepaid expenses and other current assets in the condensed consolidated balance sheets (see Note 4, “Prepaid Expenses and Other Current Assets”).  

 

During 2019, the number of pharmacies in our Partner Pharmacy Program increased from 4 to 14, placing us on track to increase Avenova sales through retail pharmacies from one-quarter to one-half of all sales. Our partner pharmacies provide patients with a quality experience that includes a relatively short time between receiving the initial prescription and filling it, fast refills and home delivery. The combination of a pre-negotiated price along with a reduction in coupon and rebate usage improves our gross-to-net and per-script profitability. During the three months ended March 31, 2020 and 2019, the revenue generated from these pharmacies comprised 12% and 25% of our total product revenue, respectively.

 

Avenova Direct 

 

In an effort to improve patient access, Avenova Direct was launched on June 1, 2019 to U.S. customers exclusively on Amazon.com. Avenova Direct is the same strength hypochlorous formulation as Avenova Rx, but comes in a 20mL size. This channel offers the Company with stable gross-to-net pricing and provides customers with easy access to our product. This model capitalizes on a trend to sell pharmaceutical products directly to consumers in response to high-deductible health plans, allowing customers to forego a time-consuming doctor visit and trip to the pharmacy. We are promoting this program through complementary social media marketing to target consumers in specific demographics, as well as to ophthalmologists, optometrists, and current and former Avenova patients. During the three months ended March 31, 2020, the revenue generated from Avenova Direct was $0.8 million.

 

KN95 Masks

 

In light of the shortage of protective masks since the outbreak of COVID-19, the Company launched its sale of KN95 disposable air filter masks on the Company’s website in March 2020. During the three months ended March 31, 2020, the revenue generated from the sale of such protective masks was $0.2 million. $18 thousand revenue was deferred from online sales as the Company had not fulfilled its obligations as of March 31, 2020.

 

The Company also received two deposits totaling $0.6 million for bulk orders that were arranged to be shipped directly out of a manufacturer in China. As the orders had not been delivered to the two customers as of March 31, 2020, the revenue was deferred. The Company had $0.6 million and $0 deferred revenue at March 31, 2020 and December 31, 2019, respectively.

 

NOTE 15. EMPLOYEE BENEFIT PLAN

 

The Company has a 401(k) plan covering all eligible employees. The Company is not required to contribute to the plan and made no contributions during either the three months ended March 31, 2020 or 2019. 

 

NOTE 16. RELATED PARTY TRANSACTIONS      

 

Related Party Financing

 

See Note 9, “Related Party Notes Payable” for a description of the Promissory Note issued on February 27, 2019, as amended on June 25, 2019 and Note 12, “Stockholders’ Equity (Deficit)” for a description of the Company’s financing transactions in June 2019 and August 2019.

 

Related Party Revenue 

 

The Company recognized related party revenues from product sales of $173 thousand for the three months ended March 31, 2020. The Company recognized related party revenues from license and collaboration fees of $41 thousand for the three months ended March 31, 2019. In fulfillment of the performance obligations under the Purchase Agreement with China Pioneer, the Company supplied product with a cost of $90 thousand and $0 for the three months ended March 31, 2020 and 2019. Related party accounts receivable was $173 thousand and $0 as of March 31, 2020 and December 31, 2019, respectively. See Note 14, “License, Collaboration and Distribution Agreements” for additional information regarding the Company’s distribution agreements with China Pioneer, the Company’s second largest stockholder.

 

Related Party Expenses 

 

During the three months ended March 31, 2020, the Company purchased KN95 masks from Earntz Nonwoven Co., Ltd. through an affiliate of China Pioneer. As of March 31, 2020 and 2019, related party accounts payable was $93 thousand and $0.

 

The Company paid related party fees of $62 thousand and $70 thousand for the three months ended March 31, 2020 and 2019, respectively. A fee of $50 thousand was paid to Director Bob Wu during both the three months ended March 31, 2020 and March 31, 2019, which represented the consulting fees pursuant to that certain Consulting Agreement, between the Company and China Kington, dated March 1, 2019. A fee of $12 thousand was paid to China Kington during the three months ended March 31, 2020 and represented the broker fee for the exercise of the June 2019 warrants by one of the warrant holders, and was recorded as a reduction to additional paid-in capital from the exercise of the warrants. A fee of $20 thousand paid to China Kington during the three months ended March 31, 2019 represented the broker fee for the issuance of the Promissory Note to Pioneer Pharma (Hong Kong) Company Ltd., and was recorded as an offset to the related party notes payable in the condensed consolidated balance sheet. See Note 9, “Related Party Notes Payable”, and Note 11, “Warrant Liability” for additional information regarding such fees.

 

NOTE 17. SUBSEQUENT EVENTS

 

On April 16, 2020, the Company entered into the following agreements: (1) an International Distribution Agreement (the “Microprofit Agreement”) with Shenzhen Microprofit Biotech Co., Ltd. (“Microprofit”), a China-based company that manufactures its proprietary product of SARS-CoV-2 IgG and IgM Antibody Combined Test Kits that have the ability to test the novel coronavirus (COVID-19) (the “Test Kits”), which has not yet been approved by the U.S. Food and Drug Administration (the “FDA”) and (2) an Intermediary Distribution Agreement (the “Pioneer Agreement”) with Chongqing Pioneer Pharma Holdings Limited (“Pioneer”), which is an affiliate of China Pioneer. Under the Microprofit Agreement, Microprofit is granting the Company the exclusive right to distribute the Test Kits upon receipt of all applicable regulatory approvals including FDA approval (the “Regulatory Approvals”). As consideration for such exclusive right, on the later of the date on which all Regulatory Approvals are received and the date of stockholder approval to increase the number of the Company's authorized shares of common stock is received, the Company will issue purchase warrants for the Company’s Common Stock to certain Microprofit officers, exercisable for an aggregate number of shares of the Company’s common stock equivalent to twelve percent (12%) of the Company’s outstanding common stock on the same date. In accordance with the Pioneer Agreement, the Company will place orders for and purchase the Test Kits from Pioneer, as an intermediary distribution partner who in turn purchases the Test Kits from Microprofit. Pioneer will receive a nominal cash profit for each Test Kit sold to the Company.

 

On April 27, 2020, NovaBay Pharmaceuticals, Inc. (the “Company”) entered into an At the Market Offering Agreement (the “Agreement”) with Ladenburg Thalmann & Co. Inc. (“Ladenburg”) to sell shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), having a current aggregate offering amount of up to $4,302,137, which offering amount may change as described in the Agreement (the “Shares”), from time to time during the term of the Agreement, through an “at the market” equity offering program under which Ladenburg will act as the Company’s sales agent (the “ATM Program”). The Company will pay Ladenburg a commission equal to three percent (3.0%) of the gross sales proceeds of any Shares sold through Ladenburg under the Agreement, and also has provided Ladenburg with customary indemnification rights. We have not, as of May 7, 2020, received any funds from the ATM Program, or been able to request any sales of our stock under the ATM Program while we are in a trading blackout.

 

On April 30, 2020, a total of 571,428 warrants to purchase 571,428 shares of common stock were exercised related to the June 2019 Warrants resulting in gross proceeds of $497 thousand.

 

On May 3, 2020, the Company entered into that certain Paycheck Protection Program Promissory Note and Agreement with Wells Fargo Bank, N.A. (the “Lender”) pursuant to which the Company will receive loan proceeds of $900,505 (the “PPP Loan”). The PPP Loan was made under, and is subject to the terms and conditions of, the Paycheck Protection Program (“PPP”), which was established under the recent congressionally-approved Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and is administered by the U.S. Small Business Administration. The term of the PPP Loan is two years with a maturity date of May 3, 2022 and the annual interest rate on the PPP Loan is a fixed rate of 1.00%. Payments of principal and interest on the loan will be deferred for the first six months of the term of the PPP Loan until November 1, 2020.  Principal and interest are payable monthly and may be prepaid by the Company at any time prior to maturity with no prepayment penalties.  Under the terms of the CARES Act, recipients can apply for and receive forgiveness for all or a portion of loans granted under the PPP. Such forgiveness will be determined, subject to limitations, based on the use of loan proceeds for certain permissible purposes as set forth in the PPP, including, but not limited to, payroll costs (as defined under the PPP) and mortgage interest, rent or utility costs (collectively, “Qualifying Expenses”), and on the maintenance of employee and compensation levels during the eight-week period following the funding of the loan. The Company intends to use the proceeds of the PPP Loan, when received, for Qualifying Expenses, including, but not limited to, to support the employment of our Avenova salesforce, which has been greatly restricted in its ability to solicit eye care professionals due to the COVID-19 “stay at home” orders. However, no assurance is provided that the Company will be able to obtain forgiveness of the PPP Loan in whole or in part. See Part II, Item 5 for further details on the PPP Loan.