SenesTech, Inc. - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2018

OR

For the transition period from_______ to _______

Commission File Number: 001-37941

SENESTECH, INC.

(Exact name of registrant as specified in its charter)

(928) 779-4143

(Registrant’s telephone number, including area code)

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  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.

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 ☒

The number of shares of common stock outstanding as of August 13, 2018: 23,425,287

SENESTECH, INC.

FORM 10-Q

For the Quarterly Period Ended June 30, 2018

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SENESTECH, INC.
BALANCE SHEETS

(In thousands, except shares and per share data)

See accompanying notes to financial statements.

SENESTECH, INC.

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except shares and per share data)
(Unaudited) 

See accompanying notes to financial statements.

SENESTECH, INC.
STATEMENTS OF CASH FLOWS

(In thousands)
(Unaudited)

See accompanying notes to financial statements.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 1 - Organization and Description of Business

SenesTech, Inc. (“SenesTech,” the “Company,” “we” or “us”) was formed in July 2004 and incorporated in the state of Nevada. The Company subsequently reincorporated in the state of Delaware in November 2015. Our corporate headquarters is in Flagstaff, Arizona. We have developed and are commercializing a global, proprietary technology for managing animal pest populations, primarily rat populations, through fertility control.

Pest management professionals (PMPs) continue to face challenges in controlling infestations. While there are many tools to bring rat populations down quickly, they are at a disadvantage: they do not prevent the rapid reproduction, leaving PMPs and their customers open to a possible rebound in rat population.

ContraPest® is a proven fertility control solution that complements integrated pest management (IPM) protocols to bring rat populations down and keep them down. Without fertility control, rat populations can rebound, but ContraPest, targets the reproductive capabilities in Norway and roof rats to minimize these population spikes and consistently keep rat populations down more effectively.

Additionally, PMPs are being increasingly asked for new solutions to help them solve their customers’ toughest rat infestations. With growing interest in non-lethal options, it is becoming increasingly important for PMPs to have proven non-lethal tools at their disposable. Our goal is to provide PMPs with this proven solution to help expand their service offering and serve customers that are looking to decrease or eliminate the amount of lethal methodologies used in their integrated pest management programs.

Our flagship fertility control product, ContraPest is a liquid fertility control bait containing the active ingredients 4-vinylcyclohexene diepoxide (“VCD”) and triptolide. When consumed, ContraPest targets reproduction, limiting fertility in male and female Norway and roof rats beginning with initial consumption. We submitted ContraPest for registration with the EPA on August 23, 2015, and the EPA granted registration approval for ContraPest effective August 2, 2016. We expect to continue to pursue regulatory approvals and amendments to existing registration in the United States for ContraPest, including additional species and additional jurisdictions.

We believe ContraPest is the first and only non-lethal, fertility control product approved by the EPA for the management of rat populations. In addition to the EPA registration of ContraPest in the U.S., we must obtain registration from the various state regulatory agencies prior to being used in each state. We have received registration for ContraPest in all 50 states and the District of Columbia.

Besides providing just the product, SenesTech provides PMPs with product training, and supports the PMPs by creating tools, training and awareness campaigns to help inform their customers, specifically within the food safety industry and larger residential customers, such as Home Owners Associations (HOAs), on the benefits of including ContraPest into their IPM protocols.

Potential Need for Additional Capital

Since our inception, we have sustained significant operating losses in the course of our research and development activities, and expect such losses to continue for the near future. We have generated limited revenue to date from product sales, research grants and licensing fees received under our former license agreement with Neogen. In 2017, we began full scale marketing of our first product, ContraPest, and we continue to develop other product candidates, which are in various phases of development. We have funded our operations to date through the sale of equity securities, including convertible preferred stock, common stock and warrants to purchase common stock. Such sales include:

We have also raised capital through debt financing, consisting primarily of convertible notes; and, to a lesser extent, payments received in connection with product sales, research grants and licensing fees. In June 2018, the Company received $2.2 million and issued 1,475,659 common shares upon the exercise of 1,475,659 warrants that were issued on November 21, 2017. In exchange for the exercise of 1,133,909 of those warrants, the Company issued new warrants to purchase an additional 1,133,909 shares with an exercise price of $1.82 per share.

Through June 30, 2018, we had received net proceeds of $56.5 million from our sales of common stock, preferred stock and warrant exercises and issuance of convertible and other promissory notes, an aggregate of $1.7 million from licensing fees and $0.1 million in product sales. At June 30, 2018, we had an accumulated deficit of $80.4 million and cash and cash equivalents and highly liquid investments of $4.3 million. 

Our ultimate success depends upon the outcome of a combination of factors, including: (i) successful commercialization of ContraPest and ongoing regulatory approval of our other product candidates; (ii) market acceptance, commercial viability and profitability of ContraPest and other products; (iii) the ability to market our products and establish an effective sales force and marketing infrastructure to generate significant revenue; (iv) the success of our research and development; (v) the ability to retain and attract key personnel to develop, operate and grow our business; and (vi) our ability to meet our working capital needs.

Based upon our current operating plan, we expect that cash and cash equivalents and highly liquid, short term investments at June 30, 2018, in combination with anticipated revenue and net proceeds of $5.4 million from the Rights Offering that closed on August 13, 2018, will be sufficient to fund our current operations for the near future. However, if anticipated revenue targets are not achieved, we may seek to reduce operating expenses and are likely to require additional capital in order to fund our operating losses and research and development activities until we become profitable. We may never achieve profitability or generate positive cash flows, and unless and until we do, we will continue to need to raise capital through equity or debt financing. If such equity or debt financing is not available at adequate levels or on acceptable terms, we may need to delay, limit or terminate development and commercialization efforts.

Basis of Presentation

The accompanying unaudited condensed financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the Company’s opinion, the unaudited condensed financial statements include all material adjustments, all of which are of a normal and recurring nature, necessary to present fairly the Company’s financial position as of June 30, 2018, the Company’s operating results for the three and six months ended June 30, 2018 and 2017, and the Company’s cash flows for the six months ended June 30, 2018 and 2017. The accompanying financial information as of December 31, 2017 is derived from audited financial statements. Interim results are not necessarily indicative of results for a full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K, as amended for the year ended December 31, 2017. All amounts shown in these financial statements and accompanying notes are in thousands, except percentages and per share and share amounts.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and classification of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. The significant estimates in the Company’s financial statements include the valuation of preferred stock, common stock and related warrants, and other stock-based awards. Actual results could differ from such estimates.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current period presentation. These reclassifications had no material impact on net earnings, financial position or cash flows.

Cash and Cash Equivalents

The Company considers money market fund investments to be cash equivalents. The Company had cash equivalents of $11 and $3 at June 30, 2018 and December 31, 2017, respectively, included in cash as reported.

Investments in Securities Held to Maturity

The Company uses cash holdings to purchase highly liquid, short term, investment grade securities diversified among security types, industries and issuers. All of the Company’s investment securities are measured at fair value. The Company’s investment securities primarily consist of municipal debt securities, corporate bonds, U.S. agency securities and commercial paper and highly-liquid money market funds.

Accounts Receivable

Accounts receivable consist primarily of trade receivables. The Company provides an allowance for doubtful trade receivables equal to the estimated uncollectible amounts. That estimate is based on historical collection experience, current economic and market conditions and a review of the current status of each customer’s trade accounts receivable. The allowance for doubtful trade receivables was $5 as of June 30, 2018 and $0 at December 31, 2017.

Deferred Offering Costs

Deferred offering costs consist primarily of legal, accounting and other direct and incremental fees and costs related to the Rights Offering that closed on August 13, 2018. Total deferred offering costs will be offset against the proceeds received from the Rights Offering during the quarter ending September 30, 2018. There were no deferred offering costs at December 31, 2017.

Inventories

Inventories are stated at the lower of cost or market value, using the first-in, first-out convention. Inventories consist of raw materials and finished goods. As of June 30, 2018 and December 31, 2017, the Company had inventories of $1.2 million and $540, respectively.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies – (continued)

Prepaid Expenses

Prepaid expenses consist primarily of payments made for director compensation as well as payments made for director and officer insurance, rent and legal deposits to be expensed in the current year.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Equipment held under capital leases are stated at the present value of minimum lease payments less accumulated amortization.

Depreciation on property and equipment is computed using the straight-line method over the estimated useful lives of the respective assets. The cost of leasehold improvements is amortized over the life of the improvement or the term of the lease, whichever is shorter. Equipment held under capital leases is amortized over the shorter of the lease term or estimated useful life of the asset. The Company incurs repair and maintenance costs on its major equipment, which are expensed as incurred.

Impairment of Long-Lived Assets

Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require long-lived assets or asset groups to be tested for possible impairment, the Company compares the undiscounted cash flows expected to be generated from the use of the asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment charge is recognized to the extent that the carrying amount exceeds its fair value. Fair value is determined through various valuation techniques, such as discounted cash flow models and the use of third-party independent appraisals. The Company has not recorded an impairment of long-lived assets since its inception.

Revenue Recognition

Effective January 1, 2018, the Company adopted ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from the commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the performance of service has been rendered to a customer or delivery has occurred; (3) the amount of the fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured. The performance obligations identified by the Company under Accounting Standards Codification (“ASC”) Topic 606, Revenue From Contracts With Customers, are similar to the unit of account and performance obligation determination under ASC Topic 605, Revenue Recognition.

There was no impact on the Company’s financial statements as a result of adopting ASC 606 for the three and six months ended June 30, 2018 and 2017, or the twelve months ended December 31, 2017

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies – (continued)

The Company derives revenue primarily from commercial sales of products.

For the three and six months ended June 30, 2018, the Company generated net revenues of $19 and $54, respectively and $10 and $17 for the three and six months ended June 30, 2017 respectively, from the sale of ContraPest.

Research and Development

Research and development costs are expensed as incurred. Research and development expenses primarily consist of salaries and benefits for research and development employees, stock-based compensation, consulting fees, lab supplies, costs incurred related to conducting scientific trials and field studies, and regulatory compliance costs. Also, included in research and development expenses is an allocation of facilities related costs, including depreciation of research and development equipment.

Stock-based Compensation

Employee stock-based awards, consisting of restricted stock units and stock options expected to be settled in shares of the Company’s common stock, are recorded as equity awards. The grant date fair value of these awards is measured using the Black-Scholes option pricing model. The Company expenses the grant date fair value of its stock options on a straight-line basis over their respective vesting periods. Performance-based awards are expensed over the performance period when the related performance goals are probable of being achieved.

For equity instruments issued to non-employees, the stock-based consideration is measured using a fair value method. The measurement of the stock-based compensation is subject to re-measurement as the underlying equity instruments vest.

The stock-based compensation expense recorded for the three and six months ended June 30, 2018 and 2017, is as follows:

See Note 13 for additional discussion on stock-based compensation.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies – (continued)

Income Taxes

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities and net operating loss carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date.

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. These deferred tax assets are subject to periodic assessments as to recoverability and if it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recorded which would increase the provision for income taxes. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.

The Company applies a more-likely-than-not recognition threshold for all tax uncertainties. Only those benefits that have a greater than fifty percent likelihood of being sustained upon examination by the taxing authorities are recognized. Based on its evaluation, the Company has concluded there are no significant uncertain tax positions requiring recognition in its financial statements.

The Company recognizes interest and/or penalties related to uncertain tax positions in income tax expense. There are no uncertain tax positions as of June 30, 2018 or December 31, 2017 and as such, no interest or penalties were recorded in income tax expense.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”).  SAB 118 provides a measurement period that should not extend beyond one year from the date of enactment for companies to complete the accounting under ASC 740, Income Taxes.  The Company is still analyzing the Tax Act and the impact, if any, it will have.

Comprehensive Loss

Net loss and comprehensive loss were the same for all periods presented; therefore, a separate statement of comprehensive loss is not included in the accompanying financial statements.

Loss Per Share Attributable to Common Stockholders

Basic loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per share attributable to common stockholders is computed by dividing the loss attributable to common stockholders by the weighted average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury stock and if-converted methods. For purposes of the computation of diluted loss per share attributable to common stockholders, common stock purchase warrants, and common stock options are considered to be potentially dilutive securities but have been excluded from the calculation of diluted loss per share attributable to common stockholders because their effect would be anti-dilutive given the net loss reported for the three and six months ended June 30, 2018 and 2017. Therefore, basic and diluted loss per share attributable to common stockholders are the same for each period presented.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies – (continued)

The following table sets forth the outstanding potentially dilutive securities that have been excluded in the calculation of diluted loss per share attributable to common stockholders (in common stock equivalent shares):

Adoption of New Accounting Standards:

In May 2014 the FASB issued ASU 2014-09, Revenue from Contracts with Customers. Since ASU 2014-09 was issued, several additional ASUs have been issued to clarify various elements of the guidance. These standards provide guidance on recognizing revenue, including a five-step model to determine when revenue recognition is appropriate. The standard requires that an entity recognize revenue to depict the transfer of control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Effective January 1, 2018, the Company adopted ASU 2014-09, “Revenue from Contracts with Customers” using the modified retrospective method to all contracts that were not completed as of the date of adoption. The results of operations for reported periods after January 1, 2018 are presented under this amended guidance, while prior period amounts are reported in accordance with ASC 605 — Revenue Recognition. There was no material impact on our financial position, results of operations, or cash flows. See Note 2 — Summary of Significant Accounting Policies — Revenue Recognition.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). This standard involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods for public business entities. The method of adoption is dependent on the specific aspect of accounting addressed in this new guidance. Early adoption was permitted in any interim or annual period. The Company has adopted the provisions of ASU 2016-09 on its financial statements. There was no material impact on our financial position, results of operations, or cash flows

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU provide guidance on the following eight specific cash flow classification issues: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company has adopted the provisions of ASU 2016-15 on its financial statements. There was no material impact on our financial position, results of operations, or cash flows.

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 2 - Summary of Significant Accounting Policies – (continued)

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This standard affects the accounting for equity instruments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 is effective the first quarter of 2018. The Company has adopted the provisions of ASU 2016-01 on its financial statements. There was no material impact on our financial position, results of operations, or cash flows.

Accounting Standards Issued But Not Yet Adopted:

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”). This standard amends various aspects of existing accounting guidance for leases, including the recognition of a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This standard also introduces new disclosure requirements for leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public business entities. Early adoption is permitted and the new standard must be adopted using a modified retrospective approach, and provides for certain practical expedients. The Company is evaluating the impact of the adoption of ASU 2016-02 on its financial statements and related disclosures.

In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The new guidance allows an entity to reclassify the income tax effects of the Public Law 115-97 “An Act to Provide Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” commonly known as the Tax Cuts and Job Act of 2017 (the “Tax Act”) on items within accumulated other comprehensive income/(loss) to retained earnings. This new guidance is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The new standard must be adopted retrospectively to each period in which a taxpayer recognizes the effect of the change in the U.S. federal corporate income tax rate from the Tax Act. The Company is currently assessing the impact of ASU 2018-02 on our consolidated financial statements and related disclosures. 

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

Note 3 - Fair Value Measurements

We invest in various short term, highly liquid financial instruments, which may include municipal debt securities, corporate bonds, U.S. agency securities and commercial paper. We value these instruments at fair value. The accounting guidance for fair value, among other things, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The framework for measuring fair value consists of a three-level valuation hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based upon whether such inputs are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions made by the reporting entity. The three-level hierarchy for the inputs to valuation techniques is briefly summarized as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2—Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

Level 3—Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.

An asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques:

The Company’s cash equivalents, which include money market funds, are classified as Level 1 because they are valued using quoted market prices. The Company’s marketable securities consist of held to maturity securities and are generally classified as Level 2 because their value is based on valuations using significant inputs derived from or corroborated by observable market data.

In certain cases where there is limited activity or less transparency around the inputs to valuation, securities are classified as Level 3. Level 3 liabilities consist of common stock warrant liability.

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 3 - Fair Value Measurements – (continued)

Items Measured at Fair Value on a Recurring Basis

The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy:

(1) The change in the fair value of the common stock warrant and convertible notes payable for the three and six months ended June 30, 2018 was recorded as a decrease to other income (expense) and interest expense of $1 and $1, respectively, in the statements of operations and comprehensive loss.

Financial Instruments Not Carried at Fair Value

The carrying amounts of the Company’s financial instruments, including accounts payable and accrued liabilities, approximate fair value due to their short maturities. The estimated fair value of the convertible notes and other notes, not recorded at fair value, are recorded at cost or amortized cost which was deemed to estimate fair value.

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 4 - Investments in Securities Held to Maturity

As of June 30, 2018, investment in securities held to maturity primarily consisted of corporate fixed income securities The Company classifies all investments as held to maturity as these investments are short term, highly liquid investments which we intend to hold to maturity. Held to maturity securities are recorded at cost plus or minus market fluctuation and gains and losses are recognized as the sale or redemption of the securities is realized. Gains and losses are included in non-operating other income (expense) on the condensed statement of operations and are derived using the specific identification method for determining the cost of the securities sold. For the three and six months ended June 30, 2018, the Company recorded $14 and $32 net gain (loss) on investments recorded, respectively. Interest and dividends on investments held to maturity are included in interest and other income, net, in the condensed statements of operations.

The following is a summary of held to maturity securities at June 30, 2018:

Note 5 - Prepaid Expenses

Prepaid expenses consist of the following:

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 6 - Property and Equipment

Property and equipment, net consist of the following:

* Shorter of lease term or estimated useful life

Depreciation and amortization expense was approximately $107 and $95 for the three months ended June 30, 2018 and 2017, respectively, and $224 and $154 for six months ended June 30, 2018 and 2017, respectively.

Note 7 - Accrued Expenses

Accrued expenses consist of the following:

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 8 - Borrowings

A summary of the Company’s borrowings, including capital lease obligations, is as follows:

Capital Lease Obligations

Capital lease obligations are for computer and lab equipment leased through GreatAmerica Financial Services, Thermo Fisher Scientific, Navitas Credit Corp. and ENGS Commercial Finance Co. These capital leases expire at various dates through April 2022 and carry interest rates ranging from 6.4% to 11.6%.

Other Promissory Notes

Also included in the table above are three notes payable to Direct Capital, one note to M2 Financing and one note to Fidelity Capital, all for the financing of fixed assets. These notes expire at various dates through June 2022 and carry interest rates ranging from 4.3% to 13.8%.

Note 9 - Notes Payable, Related Parties

A summary of the Company’s notes payable, related parties is as follows:

In April 2013, the Company and a previous employee entered into an agreement to settle all outstanding obligations consisting of a promissory note of $40, dated March 2009, and deferred salaries amounting to $72. The note and salary obligation continue to bear interest at 8% and 4.25%, respectively. The note requires monthly payments of $1 and matured in May 2018, but the final disbursement was not made until July, 2018. The deferred salary obligation required monthly payments of $1 and matured in June 2018, with final payment made in July, 2018.

Amounts outstanding on these obligations were $3 and $12 at June 30, 2018 and December 31, 2017, respectively.

Interest expense on the notes payable, related parties, was $0 for the three and six months ended June 30, 2018 and $1 for the year ended December 31, 2017 respectively.

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 10 - Common Stock Warrants and Common Stock Warrant Liability

The table summarizes the common stock warrant activity as of June 30, 2018 as follows:

(1) The common stock warrants issued in November 2017 with an initial exercise price of $1.50 per share adjusted downward to $0.95 per share effective July 24, 2018 in connection with our Rights Offering pursuant to antidilution price adjustment protection contained within those warrants.

On November 21, 2017, the Company issued a total of 4,657,500 detachable common stock warrants issued with the second public offering of 5,860,000 shares of its common stock at $1.00 per share. The common stock warrant is exercisable until five years from the date of grant. The common shares of the Company’s stock and detachable warrants exist independently as separate securities. As such, the Company estimated the fair value of the common stock warrants, exercisable at $1.50 per share, to be $661 using a lattice model based on the following significant inputs: Common stock price of $1.00; comparable company volatility of 73.8%; remaining term 5 years; dividend yield of 0% and risk-free interest rate of 1.87. The initial exercise price of these warrants was $1.50 per share, which adjusted downward to $0.95 per share in connection with the Rights Offering pursuant to antidilution price adjustment protection contained within these warrants.

On June 20, 2018, the Company entered into an agreement with a holder of 1,133,909 of the November 2017 warrants to exercise its original warrant representing 1,133,909 million shares of Common Stock for cash at the $1.50 exercise price for gross proceeds of $1.7 million and the Company issued to holder a new warrant to purchase 1,133,909 shares of Common Stock at an exercise price of $1.82 per share. In June 2018, the Company recorded stock compensation expense of $1.7 million representing the fair value of the of 1,133,909 warrants issued. The Company estimated the fair value of the common stock warrants, exercisable at $1.82 per share, to be $1.7 million using a Black Scholes model based on the following significant inputs: Common stock price of $2.11; comparable company volatility of 72.6%; remaining term 5 years; dividend yield of 0% and risk-free interest rate of 2.8%.

Also in June 2018, an additional 341,750 of the November 8, 2017 warrants were exercised for gross proceeds of $513.

SENESTECH, INC.  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 10 - Common Stock Warrants and Common Stock Warrant Liability-continued

Common Stock Warrant Issued to Underwriter of Common Stock Offering

In November 2017, the Company issued to Roth Capital Partners, LLC, as underwriter, a warrant to purchase 945,000 shares of common stock at an exercise price of $1.50 per share as consideration for providing services in connection with our common stock offering. The warrant was fully vested and exercisable on the date of issuance. The common stock warrant is exercisable until five years from the date of grant. The Company estimated the fair value of the common stock warrants, exercisable at $1.50 per share, to be $134 using a lattice model based on the following significant inputs: Common stock price of $1.00; comparable company volatility of 73.8%; remaining term 5 years; dividend yield of 0% and risk-free interest rate of 1.87%.

University of Arizona Common Stock Warrant

In connection with the June 2015 amended and restated exclusive license agreement with the University of Arizona (“University”), the Company issued to the University a common stock warrant to purchase 15,000 shares of common stock at an exercise price of $7.50 per share. The warrant was fully vested and exercisable on the date of grant, and expires, if not exercised, five years from the date of grant. In the event of a “terminating change” of the Company, as defined in the warrant agreement, the warrant holder would be paid in cash the aggregate fair market value of the underlying shares immediately prior to the consummation of the terminating change event. Due to the cash settlement provision, the derivative warrant liability was recorded at fair value and is revalued at the end of each reporting period. The changes in fair value are reported in other income (expense) in the statements of operations and comprehensive loss. The estimated fair value of the derivative warrant liability was $53 at the date of grant.

The estimated fair value of the derivative warrant liability was $1 at June 30, 2018. As this derivative warrant liability is revalued at the end of each reporting period, the fair values as determined at the date of grant and subsequent periods was based on the following significant inputs using a Monte Carlo option pricing model: common stock price of $7.91; comparable company volatility of 77.7% of the underlying common stock; risk-free rates of 1.93%; and dividend yield of 0%; including the probability assessment of a terminating change event occurring. The change in fair value of the derivative warrant liability was $1 for the three and six months ended June 30, 2018 and was recorded in other income (expense) in the accompanying statements of operations and comprehensive loss.

Note 11 - Stockholders’ Deficit

Common Stock

The Company had 18,040,497 and 16,404,195 shares of common stock issued and outstanding as of June 30, 2018 and December 31, 2017, respectively.

During the six months ended June 30, 2018, the Company issued 1,636,802 shares of common stock as follows:

an aggregate of 1,475,659 for net proceeds of $2.1 million for the exercise of the Company’s November 2017 warrants (see Note 11 for further details.), : 13,900 shares for the cashless exercise of stock options, 32,625 shares to a former employee for the net settlement of restricted stock units whose vesting accelerated upon the termination of their employment contract, 37,162 shares to a Board member in net settlement of Board compensation totaling $28 and 76,956 shares for the net settlement of restricted stock units that vested during the period.

SENESTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 12 - Stock-based Compensation

On June 12, 2018, the Company’s stockholders approved the 2018 Equity Incentive Plan (the “2018 Plan”) to replace the Company’s 2015 Equity Incentive Plan (the “2015 Plan”). The 2018 Plan authorizes the issuance of 1,000,000 shares of our common stock. In addition, up to 2,874,280 shares of our common stock currently reserved for issuance under the 2015 Plan became available for issuance under the 2018 Plan to the extent such shares were available for issuance under the 2015 Plan as of June 12, 2018 or cease to be subject to awards outstanding under the 2015 Plan, such as by expiration, cancellation, or forfeiture of such awards.

The stock-based awards are generally issued with a price equal to no less than fair value at the date of grant. Options granted under the 2018 Plan generally vest immediately, or ratably over a two- to 36-month period coinciding with their respective service periods; however, participants may exercise their options prior to vesting as provided by the 2018 Plan. Unvested shares issued for options exercised early may be subject to a repurchase by the Company if the participant terminates, at the original exercise price. Options under the 2018 Plan generally have a contractual term of five years. Certain stock option awards provide for accelerated vesting upon a change in control. As of June 30, 2018, the Company had 1,862,875 shares of common stock available for issuance under the 2018 Plan.

The Company measures the fair value of stock options with service-based and performance-based vesting criteria to employees, directors and consultants on the date of grant using the Black-Scholes option pricing model. The fair value of equity instruments issued to non-employees is re-measured as the award vests. The Black-Scholes valuation model requires the Company to make certain estimates and assumptions, including assumptions related to the expected price volatility of the Company’s stock, the period under which the options will be outstanding, the rate of return on risk-free investments, and the expected dividend yield for the Company’s stock.

The weighted-average assumptions used in the Black-Scholes option-pricing model used to calculate the fair value of options granted during the six months ended June 30, 2018, were as follows:

Due to the Company’s limited operating history and lack of company-specific historical or implied volatility, the expected volatility assumption was determined based on historical volatilities from traded options of biotech companies of comparable in size and stability, whose share prices are publicly available The expected term of options granted to employees is calculated based on the mid-point between the vesting date and the end of the contractual term according to the simplified method as described in SEC Staff Accounting Bulletin 110 because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term due to the limited period of time its awards have been outstanding. For non-employee options, the expected term of options granted is the contractual term of the options. The risk-free rate by reference to the implied yields of U.S. Treasury securities with a remaining term equal to the expected term assumed at the time of grant. The expected dividend assumption is based on the Company’s history and expectation of dividend payouts. The Company has not paid and does not intend to pay dividends on its shares of capital stock.

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 12 - Stock-based Compensation – (continued)

The table summarizes the stock option activity, for both the 2018 and the 2015 plans, for the periods indicated as follows:

The stock-based compensation expense was recorded as follows:

The allocation between research and development and selling, general and administrative expense was based on the department and services performed by the employee or non-employee.

At June 30, 2018, the total compensation cost related to unvested options not yet recognized was $1,343, which will be recognized over a weighted average period of four years, assuming the employees complete their service period required for vesting.

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 12 - Stock-based Compensation – (continued)

Restricted Stock Units

The following table summarizes restricted stock unit activity for the six months ended June 30, 2018:

Note 13 - License and Other Agreements

Neogen Corporation

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 13 - License and Other Agreements-continued

On January 23, 2017 we entered into a termination agreement (the “Settlement Agreement”) with Neogen. Pursuant to the Settlement Agreement, the parties agreed to (a) terminate the existing Exclusive License Agreement between us and Neogen dated May 15, 2014 (the “License Agreement”), with neither Neogen or us having any further obligations thereunder (other than certain confidentiality obligations); (b) dismiss with prejudice the court action filed by Neogen in the District Court for the District of Arizona on January 19, 2017 (the “Court Action”), as further described below; and (c) mutually release any and all existing or future claims between the parties and their affiliates related to or arising from the License Agreement or the Court Action. As part of the Settlement Agreement, we agreed to pay to Neogen upon the execution of the Settlement Agreement an aggregate of $1.0 million in settlement of all claims.

Bioceres/INMET S.A. Agreement

In January 2016, the Company entered into a services agreement with Bioceres, Inc. (“Bioceres”), a wholly-owned subsidiary of Bioceres S.A., a leading agricultural biotechnology company in Argentina, and its Argentinean subsidiary, Ingenieria Metabolica S.A. (“INMET”) to develop a production method for synthetic triptolide, the main ingredient in ContraPest. The Company also entered into an agency agreement with INMET whereby the Company appointed INMET as its exclusive agent to seek regulatory approval for and conduct pre-sales and marketing of its product, ContraPest, in Argentina. The Company and INMET also agreed to manufacture and distribute its product in Argentina and other countries, as mutually agreed, through a newly formed entity.

The term of the service agreement is for two years. The service agreement can be terminated at any time upon written notice by either party for any reason. The term of the agency agreement with INMET is the earlier of: (i) when the Company and INMET incorporate the joint venture entity in Argentina or (ii) January 2018. These agreements were renewed for an additional year, through January 2019.

Note 14 - Commitments and Contingencies

Legal Proceedings

The Company may be subject to legal proceedings and claims arising from contracts or other matters from time to time in the ordinary course of business. Management is not aware of any pending or threatened litigation where the ultimate disposition or resolution could have a material adverse effect on its financial position, results of operations or liquidity.

On February 20, 2018, New Enterprises, Ltd. (“New Enterprises”), filed suit in the U.S. District Court for the District of Arizona against the Company and Roth Capital Partners, LLC. The suit alleges nine counts against the Company, including that the Company engaged in common law fraud and securities fraud to induce the chairman of New Enterprises into investing in the Company; that the Company breached the lock-up agreement and tortuously interfered with prospective business advantage. New Enterprises is seeking monetary damages, including compensatory damages, punitive damages, and attorney’s fees. The Company believes there is no basis to any of the claims, and intends to vigorously defend itself, including seeking appropriate counterclaims.

SENESTECH, INC. 

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(In thousands, except share and per share data)

Note 14 - Commitments and Contingencies-continued

Lease Commitments

Rent expense was $121 and $165 for the six months ended June 30, 2018 and June 30, 2018, respectively. The future minimum lease payments under non-cancellable operating lease and future minimum capital lease payments as of June 30, 2018 are as follows:

Note 15 - Subsequent Events

Rights Offering

On August 13, 2018, the Company closed a Rights Offering. Pursuant to the Rights Offering, the Company accepted subscriptions for 5,357,052 units for a purchase price of $1.15 per unit, with each unit consisting of one share of the Company’s common stock, par value $0.001 per share, and one warrant. Each warrant included in the unit was exercisable for one share of the Company’s common stock at an exercise price of $1.15 per share. At closing of the Rights Offering, the Company issued 5,357,052 shares of its common stock and 5,357,052 warrants to purchase shares of its common stock at an exercise price of $1.15 per share. The Rights Offering generated net proceeds to the Company of approximately $5.4 million after the payment of fees and expenses related to the Rights Offering. In connection with the closing of the Rights Offering, the Company issued a warrant to purchase 267,853 shares of common stock to Maxim Partners LLC, an affiliate of the dealer-manager of the Rights Offering.

In July 2018, the Company net issued 27,738 shares of common stock for the net settlement of restricted stock units that vested during the period.

The Company has evaluated subsequent events from the balance sheet date through August 14, 2018, the date at which the financial statements were issued, and determined that there were no other items that require adjustment to or disclosure in the financial statements.

As used in this Quarterly Report on Form 10-Q, “SenesTech,” the “Company,” “we,” “us,” or “our” refer to SenesTech, Inc., a Delaware corporation.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and related notes. Some statements and information contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, notes to our condensed consolidated financial statements and elsewhere in this report are not historical facts but are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In some cases, readers can identify forward- looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other comparable terminology, which when used are meant to signify the statement as forward-looking. These forward-looking statements include, but are not limited to, our expectations regarding new accounting standards on our financial results, our expectations regarding our critical accounting policies; our expectations regarding our current operating plan, including operating expenses and revenue expectations, our beliefs regarding the use of stock-based awards as a compensation tool, our beliefs regarding certain tax positions, our beliefs regarding our revenue targets and the sufficiency of our liquidity and capital resources, our beliefs regarding ongoing litigation, our expectations regarding our significant employees, our expectations regarding commercialization of ContraPest and product development of our other product candidates, our expectations regarding our sales channel, including distributors, statements about our plans, objectives, expectations and intentions and other statements that are not historical facts. These forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and situations that are difficult to predict and that may cause our own, or our industry’s actual results, to be materially different from the future results that are expressed or implied by these statements. Accordingly, actual results may differ materially from those anticipated or expressed in such statements as a result of a variety of factors, including those discussed in Item 1A of Part II of this Report, entitled “Risk Factors,” and those contained from time to time in our other filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date made. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

Overview

Since our inception in 2004, we have devoted substantially all of our resources to organizing and staffing our company, conducting research and development activities for our product candidates, business planning, raising capital and acquiring and developing product and technology rights. Until August 2016, we did not have any products approved for sale, and we have generated minimal revenue from product sales to date. We have primarily funded our operations to date with proceeds from the sale of common stock and preferred stock, the issuance of convertible and other promissory notes and, to a lesser extent, payments received in connection with research grants and licensing fees. Through June 30, 2018, we had received net proceeds of $56.5 million from our sales of common stock, preferred stock and warrant exercises and issuance of convertible and other promissory notes, an aggregate of $1.7 million from licensing fees and $0.1 million in product sales. At June 30, 2018, we had an accumulated deficit of $80.4 million and cash and cash equivalents and highly liquid investments of $4.3 million.

We have incurred significant operating losses every year since our inception. Our net losses were $4.1 million, $6.8 million and $12.3 million for the three and six months ended June 30, 2018 and the year ended December 31, 2017, respectively. As of June 30, 2018, we had an accumulated deficit of $80.4 million. We expect to continue to incur significant expenses and generate operating losses for at least the next 12 months.

We have historically utilized, and intend to continue to utilize, various forms of stock-based awards in order to hire, retain and motivate talented employees, consultants and directors and encourage them to devote their best efforts to our business and financial success. In addition, we believe that our ability to grant stock-based awards is a valuable and necessary compensation tool that aligns the long-term financial interests of our employees, consultants and directors with the financial interests of our stockholders.

As a result, a significant portion of our operating expenses includes stock-based compensation expense. Stock-based compensation expense has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy. Specifically, our stock-based compensation expense for the six months ended June 30, 2018 and June 30, 2017, was $2.7 million and $1.9 million, respectively, which represented 40.0% and 26.5%, respectively, of our total operating expenses for those periods.

Components of our Results of Operations

Revenue

We recognized net product sales revenue of $36,000 and $10,000 for the three months ended June 30, 2018 and 2017, respectively, and $55,000 and $17,000 and for the six months ended June 30, 2018 and 2017, respectively. The increase in our product sales revenue was a result of increased sales of ContraPest to our distributors. Prior to 2017, all of our revenue was derived from payments received in connection with research grants and licensing fees received under the former license agreement with Neogen. We recognized $0 revenue for the three and six months ended June 30, 2018 and June 30, 2017, respectively, for services performed under NIH grants and in licensing fees under our former license agreement with Neogen. We do not anticipate additional grant revenue under the NIH grants or additional revenue from our former license agreement with Neogen.

Operating Expenses

Research and Development Expenses

Research and development expenses consist primarily of costs incurred in connection with the research and development of ContraPest and our other product candidates, which include:

●          Employee related expenses, including salaries, related benefits, travel and stock-based compensation expense for employees engaged in research and development functions;

●          Expenses incurred in connection with the development of our product candidates; and

●          Facilities, depreciation and other expenses, which include direct and allocated expenses for rent and maintenance of facilities, insurance and supplies.

We expense research and development costs as incurred.

We continue to investigate other applications of our core technology to other product candidates, which includes laboratory tests and academic collaborations. We also continue to develop our supply chain, particularly identifying and improving our sourcing of triptolide, a key active ingredient for our product candidates. At this time, we cannot reasonably estimate the costs for further development of ContraPest or the cost associated with the development of any of our other product candidates.

We plan to continue to hire employees to support our research and development efforts and anticipate that we will continue to utilize various forms of stock-based compensation awards in order to attract and retain employees for our research and development efforts. As a result, we anticipate that stock-based compensation expense will continue to represent a significant portion of our research and development expenses for the foreseeable future.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries and related costs, including stock-based compensation, for personnel in executive, finance, sales, marketing and administrative functions. Selling, general and administrative expenses also include direct and allocated facility-related costs as well as professional fees for legal, consulting, accounting and audit services.

We anticipate that our selling, general and administrative expenses may increase in the future as we increase our headcount to support commercialization of ContraPest and further development of our product candidates. We also anticipate that we will incur increased accounting, audit, legal, regulatory, compliance, director and officer insurance costs as well as investor and public relations expenses associated with being a public company.

We plan to continue to hire employees to support our commercialization of ContraPest and further development of our product candidates, and anticipate that we will continue to utilize various forms of stock-based compensation awards in order to attract and retain qualified employees. As a result, we anticipate that stock-based compensation expense will continue to represent a significant portion of our selling, general and administrative expenses for the foreseeable future.

Other Income (Expense), Net

Interest Income. Interest income consists primarily of interest income earned on cash and cash equivalents. Prior to 2017, our interest income has not been significant due to nominal cash and investment balances and low interest earned on invested balances. For the three months and six months ended June 30, 2018, we recorded $1,000 and $7,000 of interest income on our cash and short term, highly liquid investments, respectively, compared to $1,000 and $11,000 for the three months and six months ended June 30, 2017, respectively. The decrease in interest income was primarily due to a decrease in investments as monies previously invested were used for operating expenses.

Interest Expense. Interest expense for the six months ended June 30, 2018 and the year ended December 31, 2017 consists primarily of interest accrued on our capital lease and note commitments. For the three months and six months ended June 30, 2018, we recorded $22,000 and $44,000 of interest expense, respectively, compared to $8,000 and $21,000 for the three months and six months ended June 30, 2017, respectively. The increase in interest expense was primarily due to an increase in note commitments during 2017 for asset acquisitions.

Other Income (Expense), Net. Other income (expense), net, consists primarily of recognized change in value of short-term investments and income (expense) related to the year-over-year fair market value adjustment of our derivative warrant and losses associated with the early extinguishment of debt. We recorded other expense of $7,000 and other income of $6,000 of other income, net, for the three months and six months ended June 30, 2018, respectively, compared to other income of $31,000 and $39,000 for the three months and six months ended June 30, 2017, respectively. The decrease in other income was primarily due to a $10,000 loss on extinguishment of debt and less fluctuation in the fair market value of our derivative warrant resulting in less income from reduced derivative warrant liability.

Income Taxes

Deferred tax assets and liabilities are determined based on differences between the financial statement and tax basis of assets and liabilities, as well as a consideration of net operating loss and credit carry forwards, using enacted tax rates in effect for the period in which the differences are expected to impact taxable income. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company’s effective tax rate for the three and six months ended June 30, 2018 and the year ended December 31, 2017 has been affected by the valuation allowance on the Company’s deferred tax assets.

Since our inception, we have not recorded any U.S. federal or state income tax benefits for the net losses we have incurred in each year or for our earned research and development tax credits, due to our uncertainty of realizing a benefit from those items. As of June 30, 2018, we had federal net operating loss carryforwards of $49.2 million which begin to expire in 2023 and state net operating loss carryforwards of $38.4 million which began to expire in 2016, unless utilized.

Comparison of the Three and Six Months Ended June 30, 2018 and 2017

The following table summarizes our results of operations for the three and six months ended June 30, 2018 and 2017:

SENESTECH, INC.

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except shares and per share data)

(Unaudited) 

Three Months Ended June 30, 2018 compared to Three Months Ended June 30, 2017:

Revenue

Revenue was $36,000 for the three months ended June 30, 2018, compared to $10,000 for three months ended June 30, 2017. The increase in our product sales revenue of $26,000 was a result of increased sales of ContraPest through our distributor channels.

Cost of Goods Sold

Cost of goods sold was $20,000 for the three months ended June 30, 2018, compared to $12,000 for three months ended June 30, 2017. The increase in cost of goods sold corresponded to the increase in sales of ContraPest.

Research and Development Expenses

Research and development expenses were $636,000 for the three months ended June 30, 2018, compared to $973,000 for the same period in 2017. The $337,000 decrease in research and development expenses was primarily due to a decrease of $189,000 in professional fees/consultant expenses, a decrease in personnel-related costs of $47,000, a decrease in facility expenses of $20,000 and a decrease in other expenses of $81,000. The decrease in personnel-related costs resulted from an increase in research and development salaries of $34,000 due to additional headcount offset by a decrease in stock-based compensation expense of $61,000 and reduced employee benefits of $20,000. Professional services and consulting expenses decreased $189,000 for the three months ended June 30, 2018, compared to the same period in 2017 primarily due to a decrease in synthetic triptolide research fees and legal fees associated with regulatory approval. . Rent and utilities for the three months ended June 30, 2018 decreased $20,000 over the same period in 2017 due primarily to a decrease in rent expense. Other expenses decreased by $81,000 to $201,000 for the three months ended June 30, 2018 as compared to $282,000 for the same period in 2017, primarily due to decreased travel expenses of $24,000 related to reduced field team on-site evaluations of potential customers and research operations, decreased depreciation expense of $19,000, lower training expenses of $18,000, lower lab fees of $10,000 and reduced office and supplies expenses of $10,000.

We continue to investigate applications of our core technology to other product candidates, which includes laboratory tests and academic collaborations. We also continue to develop our supply chain, particularly identifying and improving our sourcing of triptolide, a key active ingredient for our product candidates.

General and Administrative Expenses

General and administrative expenses were $3.5 million for the three months ended June 30, 2018, compared to $2.6 million for the three months ended June 30, 2017. The increase of $0.9 million in general and administrative expenses was primarily due to an increase of $896,000 in personnel related expenses, an increase of $19,000 in insurance expenses related to the increased D&O insurance expense and an increase in trade show expenses of $36,000 due to the commercialization of ContraPest, offset by a decrease of $14,000 in travel expenses and a decrease of $41,000 in professional services expenses due to lower sales consulting and Inmet contract fees. The increase in personnel related expenses consisted of an increase in stock-based compensation of $1.2 million, primarily due to stock compensation expense of $1.7 million associated with inducement warrants issued in June, offset by a decrease of $512,000 in net salary costs due to reduced payroll taxes associated with net settlement tax expense and non-inducement grant stock compensation.

Interest Expense

We recorded $21,000 of interest expense, net for the three months ended June 30, 2018, compared to $7,000 for the same period in 2017. The increase in interest expense of $14,000 was the result of increased debt in the form of notes payable and leases on equipment acquisitions during 2017.

Other Income (Expense), Net

We recorded $7,000 of other expense, net for the three months ended June 30, 2018, compared to $31,000 of other income for the same period in 2017. The $38,000 net decrease in other income was primarily due to lower income recognized for year-over-year fair market value adjustment of our convertible promissory notes a $10,000 loss on the early extinguishment of a note payable.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017:

Revenue

Revenue was $55,000 for the six months ended June 30, 2018, compared to $17,000 for three months ended June 30, 2017. The increase in our product sales revenue of $26,000 was a result of increased sales of ContraPest  through our distributor channels.

Cost of Goods Sold

Cost of goods sold was $39,000 for the six months ended June 30, 2018, compared to $16,000 for six months ended June 30, 2017. The increase in cost of goods sold corresponded to the increase in product sales.

Research and Development Expenses

Research and development expenses were approximately $1.3 million for the six months ended June 30, 2018, compared to approximately $1.8 million for the same period in 2017. The $500,000 decrease in research and development expenses was partially due to a decrease of $79,000 in personnel-related costs. This decrease in personnel-related costs resulted from increased research and development salaries of $47,000 due to headcount additions in the fourth quarter of 2017 offset by a decrease in stock-based compensation expense of $126,000. Professional services and consulting expenses decreased $211,000 for the six months ended June 30, 2018 compared to the same period in 2017 primarily due to lower synthetic triptolide research fees and legal fees. Facilities expenses for the six months ended June 30, 2018 were lower than the same period in in 2017 by $39,000 due to the termination of a lease on the east coast for field operations. Other expenses for the six months ended June 30, 2018 were lower by $197,000 due to a reduction of supplies and maintenance expenses.

We continue to investigate applications of our core technology to other product candidates, which includes laboratory tests and academic collaborations. We also continue to develop our supply chain, particularly identifying and improving our sourcing of triptolide, a key active ingredient for our product candidates.

General and Administrative Expenses

General and administrative expenses were $5.5 million for the six months ended June 30, 2018, compared to $5.3 million for the six months ended June 30, 2017. The increase of $0.2 million in general and administrative expenses was due to an increase of $300,000 in personnel related expenses, a decrease in professional service/consultant expenses of $330,000, a decrease in travel and entertainment expenses of $121,000 and a decrease in office and expensed computer expenses of $50,000, offset by an increase in insurance expenses, primarily director and officer insurance. The increase in personnel related expenses consisted of an increase in stock based compensation of $800,000, primarily due to stock compensation expense related to the issuance of warrants, offset by a decrease of $105,000 in recruiting expenses and a decrease of $395,000 in payroll taxes, reflecting lower net settlement tax charges. The decrease in professional service and consulting expenses was primarily due to lower spending in research related to the Inmet contract.

Interest Expense

We recorded $37,000 of interest expense, net for the six months ended June 30, 2018, compared to $11,000 for the same period in 2017. The increase in interest expense of $26,000 was the result of increased debt in the form of notes payable and leases on equipment acquisitions during 2017.

Other Income (Expense), Net

We recorded $6,000 of other income, net, for the six months ended June 30, 2018, compared to $39,000 of other expense for the same period in 2017. The $33,000 net decrease in other income was primarily due to lower income recognized for year-over-year fair market value adjustment of our convertible promissory notes a $10,000 loss on the early extinguishment of a note payable in the six months ended June 30, 2018.

Liquidity and Capital Resources

Since our inception, we have sustained significant operating losses in the course of our research and development activities and commercialization efforts, and expect such losses to continue for the near future. We have generated limited revenue to date from product sales, research grants and licensing fees received under our former license agreement with Neogen. In 2017, we began full scale marketing of our first product, ContraPest, and we continue to develop other product candidates, which are in various phases of development. We have funded our operations to date through the sale of equity securities, including convertible preferred stock, common stock and warrants to purchase common stock, debt financing, consisting primarily of convertible notes; and, to a lesser extent, payments received in connection with product sales, research grants and licensing fees. Through June 30, 2018, we had received net proceeds of $56.5 million from our sales of common stock, preferred stock and warrant exercises and issuance of convertible and other promissory notes, and an aggregate of $1.7 million from licensing fees. At June 30, 2018, we had an accumulated deficit of $80.4 million and cash and cash equivalents and highly liquid investments of $4.3 million. 

Our ultimate success depends upon the outcome of a combination of factors, including: (i) successful commercialization of ContraPest and ongoing regulatory approval of our other product candidates; (ii) market acceptance, commercial viability and profitability of ContraPest and other products; (iii) the ability to market our products and establish an effective sales force and marketing infrastructure to generate significant revenue; (iv) the success of our research and development; (v) the ability to retain and attract key personnel to develop, operate and grow our business; and (vi) our ability to meet our working capital needs.

Based upon our current operating plan, we expect that cash and cash equivalents and highly liquid, short term investments at June 30, 2018, in combination with anticipated revenue and net proceeds of $5.4 million from the Rights Offering that closed on August 13, 2018, will be sufficient to fund our current operations for the near future. However, if anticipated revenue targets are not achieved, we may seek to reduce operating expenses and are likely to require additional capital in order to fund our operating losses and research and development activities until we become profitable. We may never achieve profitability or generate positive cash flows, and unless and until we do, we will need to continue to need to raise capital through equity or debt financing. If such equity or debt financing is not available at adequate levels or on acceptable terms, we may need to delay, limit or terminate development and commercialization efforts. 

Additional Funding Requirements

We expect our expenses to increase in connection with our ongoing activities, particularly as we market and focus on sales of ContraPest, and as we advance field studies of our product candidates in development. In addition, we will continue to incur costs associated with operating as a public company.

In particular, we expect to incur substantial and increased expenses as we:

Cash Flows

The following table summarizes our sources and uses of cash for each of the periods presented:

Operating Activities

During the six months ended June 30, 2018, operating activities used $4.6 million of cash, primarily resulting from our net loss of $6.8 million and by changes in our operating assets and liabilities of $733,000, partially offset by non-cash charges of $3.0 million, consisting primarily of stock-based compensation, depreciation and amortization. Our net loss was primarily attributable to research and development activities and our selling, general and administrative expenses, as we generated limited product revenue during the period. Net cash used by changes in our operating assets and liabilities for the six months ended June 30, 2018 consisted primarily of an increase in inventory of $648,000, prepaid expenses of $32,000, a decrease in accounts payable/accrued expenses of $27,000, an increase in receivables of $21,000 and a decrease in deferred rent, offset by a decrease in deposits of $7,000.

During the six months ended June 30, 2017, operating activities used $5.6 million of cash, primarily resulting from our net loss of $7.0 million and by changes in our operating assets and liabilities of $0.6 million, partially offset by non-cash charges of $2.0 million. Our net loss was primarily attributed to research and development activities and our general and administrative expenses, as we generated limited product revenue during the period. Net cash used by changes in our operating assets and liabilities for the six months ended June 30, 2017 consisted primarily of a decrease in prepaid expenses of $145,000 and an increase in deferred rent of $13,000, offset by a net decrease in accrued expenses and accounts payable of $277,000, a net increase in inventories of $243,000, an increase in deposits of $217,000 and an increase of accounts receivable of $1,000. The net decrease in accrued expenses and accounts payable was primarily due to timing of expense occurrence and payables management, offset by our payment of the $1.0 million contract cancellation settlement accrual in January.

Investing Activities

For the six months ended June 30, 2018, net cash of $2.7 million was provided by investing activities consisting of $2.6 million of proceeds received from the sale of securities held to maturity and $185,000 of proceeds from the sale of equipment offset by $102,000 in purchases of property and equipment.

For the six months ended June 30, 2017, we used $3.8 million in investing activities consisting of $2.9 million of purchases in securities to be held to maturity and $863,000 in purchases of property and equipment.

Financing Activities

During the six months ended June 30, 2018, net cash provided by financing activities was $1.6 million as a result of $2.2 million in proceeds from warrant exercises offset by payments of $335,000 of deferred offering costs, $207,000 of repayments of related to notes payable and notes payable, related party, $36,000 in repayments of capital lease obligations and $27,000 of payments for employee withholding taxes related to share-based awards.

During the six months ended June 30, 2017, net cash provided by financing activities was $287,000 as a result of $389,000 of proceeds from the issuance notes payable offset by repayments of $39,000 related to notes payable and notes payable related party and $63,000 in repayments of capital lease obligations.

Off-Balance Sheet Arrangements

As of September 30, 2017, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

Recent Developments

None

Critical Accounting Policies and Significant Judgments and Estimates

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are described in more detail in Note 2 to our financial statements included elsewhere in this Quarterly Report on Form 10-Q, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Effective January 1, 2018, the Company adopted ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from the commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the performance of service has been rendered to a customer or delivery has occurred; (3) the amount of fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured.

There was no impact on the Company’s financial statements as a result of adopting ASC 606 for the three months ended and six months ended June 30, 2018 and 2017, or the twelve months ended December 31, 2017.

Stock-Based Compensation

We recognize compensation costs related to stock options granted to employees based on the estimated fair value of the awards on the date of grant, net of estimated forfeitures, in accordance with ASC Topic 718 — Stock Compensation (“ASC 718”). We estimate the grant date fair value of the awards, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the vesting period of the respective award. We account for stock-based compensation arrangements with non-employees using a fair value approach. The fair value of these stock options is measured using the Black-Scholes option-pricing model reflecting the same assumptions as applied to employee options in each of the reported periods, other than the expected life, which is assumed to be the remaining contractual life of the option. The fair value of the stock options granted to non-employees is re-measured as the stock options vest and is recognized in the statements of operations and comprehensive loss during the period the related services are rendered.

We recorded stock-based compensation expense of approximately $2.0 million and $1.0 million for the three and six months ended June 30, 2018, respectively and $2.7 million and $1.9 million for the three and six months ended June 30, 2017, respectively. We expect to continue to grant stock options and other equity-based awards in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase.

The Black-Scholes option-pricing model requires the use of highly subjective and complex assumptions, which determine the fair value of stock-based awards. If we had made different assumptions, our stock-based compensation expense, net loss and loss per share of common stock could have been significantly different. Our assumptions are as follows:

Significant Factors, Assumptions and Methodologies Used in Determining Fair Value of Our Common Stock

As noted above, we are required to estimate the fair value of the common stock underlying our stock-based awards when performing the fair value calculations using the Black-Scholes option-pricing model. Before the consummation of our initial public offering, and in the absence of an active market for our common stock, we utilized methodologies in accordance with the framework of the American Institute of Certified Public Accountants’ Technical Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation, to estimate the fair value of our common stock.

The assumptions underlying these valuations represent management’s best estimates, which involve inherent uncertainties and the application of management’s judgment. If we had made different assumptions than those used, the amount of our stock-based compensation expense, net income and net income per share amounts could have been significantly different. The fair value per share of our common stock for purposes of determining stock-based compensation expense is the closing price of our common stock as reported on the applicable grant date. The compensation cost that has been included in the statements of operations and comprehensive loss for all stock-based compensation arrangements is as follows:

The intrinsic value of stock options outstanding as of June 30, 2018 was $103,000

Emerging Growth Company Status

The Jumpstart Our Business Startups Act of 2012, or the JOBS Act, permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies until those standards would otherwise apply to private companies. We have irrevocably elected to “opt out” of this provision and, as a result, we intend to comply with new or revised accounting standards when they are required to be adopted by public companies that are not emerging growth companies.

Not required for smaller reporting companies.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”)), under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e)) as of the end of the period covered by this report. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that this information is accumulated and communicated to management, including the principal executive and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2018, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

There have been no material changes to the Legal Proceedings set forth in in the risk factors set forth in Part I, Item 3 “Legal Proceedings” in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2017.

The following risk factors and other information included in this Report include any material changes to and supersede the description of the risk factors associated with our business previously disclosed in our Annual Report on Form 10-K for the year ended December 30, 2017, as amended, and should be carefully considered before making an investment decision relating to our common stock. If any of the risks described below occur, our business, financial condition, operating results, and cash flows could be materially adversely affected. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and financial results.

Risks Relating to our Business

Our products, including ContraPest and our other product candidates if approved, may not achieve adequate market acceptance necessary for commercial success.

Even following receipt of regulatory approval for ContraPest or future regulatory approval of our other product candidates, such products may not gain market acceptance. Market acceptance of any of our product candidates for which we receive approval depends on a number of factors, including:

Depending on the commercial success of ContraPest, we may require additional capital to fund our operations. Failure to obtain this necessary capital if needed may force us to delay, limit, or terminate our product development efforts or other operations.

Developing product candidates, including conducting experiments and field studies, obtaining and maintaining regulatory approval and commercializing any products later approved for sale, is a time-consuming, expensive and uncertain process that takes years to complete. We expect our expenses to continue to increase in connection with our ongoing activities, particularly as we advance our commercialization activities. We plan to substantially expand our operations, and as a result of many factors, some of which may be currently unknown to us, our expenses may be higher than expected. Securing additional financing may divert our management from their day-to-day activities, which may adversely affect our ability to develop and commercialize our products, including ContraPest. In addition, we cannot guarantee that future financing will be available in sufficient amounts or on terms acceptable to us, if at all. If we are unable to raise additional capital when required or on acceptable terms, we may be required to:

The occurrence of any of the events described above would have a material adverse effect on our business, operating results and prospects and on our ability to develop our product candidates.

If any of our product candidates are approved but fail to achieve market acceptance, we will not be able to generate significant revenues, which would compromise our ability to become profitable. Furthermore, the commercial success of ContraPest will depend on a number of factors, including the following:

Many of these factors are beyond our control. If we are unable to successfully commercialize our products, including ContraPest, we may not be able to earn sufficient revenues to continue our business.

ContraPest is the first product we have marketed, and if we are unable to establish an effective sales force and marketing and distribution infrastructures, or enter into and rely upon acceptable third-party relationships, we may be unable to generate meaningful revenue.

We are developing but do not currently have a fully functional infrastructure for the sales, marketing, and distribution of our products and the cost of establishing and maintaining such an infrastructure may exceed the cost-effectiveness of doing so. In order to market ContraPest and any other products that may be approved by the EPA and comparable foreign regulatory authorities, we must continue to build our sales, marketing, managerial and other non-technical capabilities or make arrangements with third parties to perform these services for which we would incur substantial costs. If we are unable to establish adequate sales, marketing, and distribution capabilities, whether independently or with third parties, we may not be able to generate meaningful product revenue and may not become profitable. Without an effective internal commercial organization or the support of a third party to perform sales and marketing functions, we may be unable to compete successfully against more established companies.

Our future success is dependent on the commercialization of ContraPest and regulatory approval and commercialization of our other product candidates.

The EPA granted registration approval for ContraPest effective August 2, 2016 and as of July 12, 2018, we have received registration for ContraPest in all 50 states and the District of Columbia. However, we have not yet had meaningful sales of ContraPest, which is our only product to date that is available for commercialization and the generation of revenue.

We cannot commercialize our other product candidates in the U.S. without first obtaining regulatory approval for each product and each use pattern from the EPA or, if applicable, the Food and Drug Administration, or FDA, and from any related applicable state authorities. Before obtaining regulatory approvals for the commercial sale of any product candidate for a target indication, the law requires that applicants demonstrate through laboratory and field studies and related data that the product candidate will perform its intended function without causing unreasonable adverse effects on the environment. The EPA or a comparable foreign regulatory authority may require more information, including additional data to support approval that may delay or prevent approval.

Regulatory approval processes of the EPA and comparable foreign regulatory authorities are lengthy, time-consuming and unpredictable, and if we are ultimately unable to obtain regulatory approval for our product candidates or the desired classification, our business may fail.

Although we obtained EPA approval for ContraPest in less than one year, the EPA review process for a product with one or more new active ingredients typically takes approximately two years to complete and approval is never guaranteed. Additionally, we have requested that the EPA consider the reclassification of ContraPest from a “Restricted Use” to a “General Use” pesticide. The EPA could not approve the reclassification of ContraPest, or our other product candidates could fail to receive marketing approval from the EPA or, with respect to ContraPest or our other product candidates, from a comparable foreign regulatory authority for many reasons, including:

Any of these factors, some of which are beyond our control, could jeopardize our ability to obtain regulatory approval for and successfully market any of our product candidates. Any such setback in our pursuit of regulatory approval would have a material adverse effect on our business, operating results and prospects.

Even following receipt of any regulatory approval for ContraPest and our other product candidates, we will continue to face extensive regulatory requirements and our products may face future development and regulatory difficulties.

Even following receipt of any regulatory approval for ContraPest or our product candidates, such products will be subject to ongoing requirements by the EPA and comparable state and foreign regulatory authorities governing the manufacture, quality control, further development, labeling, packaging, storage, distribution, safety surveillance, import, export, advertising, promotion, recordkeeping, and reporting of safety and other post-market information. The safety profile of any product will continue to be closely monitored by the EPA and comparable foreign regulatory authorities after approval. If the EPA or comparable foreign regulatory authorities become aware of new safety information related to ContraPest or any other product candidate, a number of potentially significant negative consequences could result, including:

Any of these events could prevent us from achieving or maintaining market acceptance of the particular product candidate, if approved, and could significantly harm our business, results of operations and prospects.

Moreover, existing government regulations may change and additional government regulations may be enacted that could prevent, limit, or delay regulatory approval of ContraPest or any other product candidates. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing approval that we may have obtained and/or be

subject to fines or enhanced government oversight and reporting obligations, which would adversely affect our business, prospects, and ability to achieve or sustain profitability.

Even following receipt of any regulatory approval for ContraPest and our other product candidates, we will continue to be subject to regulation of our manufacturing processes and advertising practices.

As a manufacturers of pest control products, we are subject to continual government oversight and periodic inspections by the EPA and other regulatory authorities. If we or a regulatory agency discover problems with a facility where our products are manufactured, a regulatory agency may impose restrictions on the manufacturing facility, including requiring recall or withdrawal of the product from the market or suspension of manufacturing until certain procedural requirements have been met. The occurrence of any such event or penalty could limit our ability to market ContraPest or any other product candidates and generate revenue.

In addition, the EPA strictly regulates the advertising and promotion of pest control products, and these pest control products may only be marketed or promoted for their EPA approved uses, consistent with the product’s approved labeling. Advertising and promotion of any product candidate that obtains approval in the U.S. will be heavily scrutinized by the EPA, other applicable state regulatory agencies and the public. Violations, including promotion of our products for unapproved or off-label uses, are subject to enforcement actions, inquiries and investigations, and civil, criminal and/or administrative sanctions imposed by the EPA, which could have a material adverse effect on our business, operating results and financial condition.

Failure to obtain regulatory approval in foreign jurisdictions would prevent ContraPest or any other product candidates from being marketed in those jurisdictions.

To market and sell our products globally, we must obtain separate marketing approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval may differ substantially from that required to obtain EPA approval. Obtaining foreign regulatory approvals and maintaining compliance with foreign regulatory requirements could result in significant delays, difficulties, and cost for us and could delay or prevent the introduction of our products in certain countries. Approval by the EPA does not ensure approval by regulatory authorities in other countries or jurisdictions. If we are unable to obtain approval of ContraPest or for any of our other product candidates by regulatory authorities in the global market, the commercial prospects of that product candidate would be limited and our business prospects could decline, which could have a material adverse effect on our business, operating results and financial condition.

We have internal manufacturing capabilities to meet our current demand for ContraPest, however, we must develop additional manufacturing capability or rely upon third parties to manufacture our products to meet future demand.

Our existing internal manufacturing platform is adequate for meeting our current demand for ContraPest . We may be required to spend significant time and resources to expand these manufacturing facilities to fully meet future demand. If we are unable to develop full-scale manufacturing capabilities, we may not be able to meet demand of our products without relying on third party manufacturers, which could adversely affect our operations or financial condition.

We will need to expand our operations and grow the size of our organization, and we may experience difficulties in managing this growth.

As of June 30, 2018, we had 42 full-time and four part-time employees. As our development and commercialization plans and strategies develop, or as a result of acquisitions, we will need additional managerial, operational, sales, marketing, scientific, financial headcount, and other resources. Our management, personnel, and systems currently in place may not be adequate to support this future growth. Future growth would impose significant added responsibilities on members of management, including:

Our failure to accomplish any of these tasks could prevent us from successfully growing our business.

We depend on key personnel to operate our business. If we are unable to retain, attract, and integrate qualified personnel, our ability to develop and successfully grow our business could be harmed.

We believe that our future success is highly dependent on the contributions of our significant employees, as well as our ability to attract and retain highly skilled and experienced sales, research and development, and other personnel in the U.S. and internationally. All of our employees, including our co-founders (one of which is also our chief executive officer), are free to terminate their employment relationship with us at any time, subject to any applicable notice requirements, and their knowledge of our business and industry would be difficult to replace. If one or more of our co-founders, executive officers or significant employees terminates his or her employment or becomes disabled or experiences long-term illness, we may not be able to replace their expertise, fully integrate new personnel or replicate the prior working relationships, and the loss of their services might significantly delay or prevent the achievement of our research, development and business objectives. Qualified individuals with the breadth of skills and experience in our industry that we require are in high demand, and we may incur significant costs to attract them. Many of the other companies that we compete against for qualified personnel have greater financial and other resources, different risk profiles, and a more established history in the industry. They also may provide more diverse opportunities and better chances for career advancement. Additionally, our facilities are located in Arizona, which may make attracting and retaining qualified scientific and technical personnel from outside of Arizona difficult. Our failure to attract or retain key personnel could impede the achievement of our research, development, and commercialization objectives.

We have not fully designed, implemented or assessed our internal control over financial reporting. We have previously identified and may in the future identify material weaknesses in our internal control over financial reporting. If we experience additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect investor confidence in us and, as a result, the value of our common stock.

In connection with the preparation of our consolidated financial statements as of and for the year ended December 31, 2015, we identified a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis.

We are in the process of implementing measures designed further to improve our internal control over financial reporting, including how to remediate any identified material weakness in our internal controls, including:

This quarterly report does not include an attestation report of the company’s registered public accounting firm due to a transition period established by rules of the SEC for smaller reporting companies and emerging growth companies. As a result, we have not yet fully assessed our internal control over financial reporting and are unable to assure that the measures we have taken to date, together with any measures we may take in the future, will be sufficient to remediate the control deficiencies that led to our material weaknesses in our internal control over financial reporting, or to avoid potential future material weaknesses.

If we are unable to design and implement an effective system of internal control over financial reporting, successfully remediate any existing or future material weaknesses in our internal control over financial reporting, or identify any additional material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports and Nasdaq listing requirements, investors may lose confidence in our financial reporting, and our stock price may decline as a result.

We may be subject to legal proceedings in the ordinary course of our business that could result in significant harm to our business, financial condition and operating results.

We could be subject to legal proceedings and claims from time to time in the ordinary course of our business, including actions arising from tort, contract or other claims. Litigation is expensive, time consuming, and could divert management’s attention away from running our business. The outcome of litigation or other proceedings is subject to significant uncertainty, and it is possible that an adverse resolution of one or more such proceedings could result in reputational harm and/or significant monetary damages, injunctive relief or settlement costs that could adversely affect our results of operations or financial condition as well as our ability to conduct our business as it is presently being conducted. Insurance might not cover such claims, might not provide sufficient payments to cover all the costs to resolve one or more such claims, and might not be available on terms acceptable to us. In addition, regardless of merit or outcome, claims brought against us that are uninsured or underinsured could result in unanticipated costs, which could harm our business, financial condition and operating results and reduce the trading price of our stock.

Product liability lawsuits against us could cause us to incur substantial liabilities and to limit commercialization of any products that we may develop.

We face an inherent risk of product liability exposure related to the use of ContraPest and any of our other products. If we cannot successfully defend ourselves against claims from our product users, we could incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:

We may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing. Large judgments have been awarded in class action lawsuits based on products that had unanticipated side effects, including, without limitation, any potential adverse effects of our products on humans or other species. A successful product liability claim or series of claims brought against us, particularly if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.

Business or supply chain disruptions could seriously harm our future revenues and financial condition and increase our costs and expenses.

Our operations could be subject to a variety of potential business disruptions, including power shortages, telecommunications failures, water shortages, floods, fires, earthquakes, extreme weather conditions, medical

epidemics and other natural or manmade disasters or other interruptions, for which we are predominantly self-insured. We do not carry insurance for all categories of risk that our business may encounter. The occurrence of any of these business disruptions could seriously harm our operations and financial condition and increase our costs and expenses. Moreover, we rely on various third parties to supply various ingredients and other items which are critical for producing our product candidates. Our ability to produce our product candidates would be disrupted if the operations of these suppliers are affected by a manmade or natural disaster or other business interruption. The ultimate impact on our operations from any business interruption impacting us or any of our significant suppliers is unknown, but our operations and financial condition would likely suffer material adverse consequences. Further, any significant uninsured liability may require us to pay substantial amounts, which would adversely affect our business, results of operations, financial condition, and cash flows from future prospects.

We are dependent on triptolide, a key ingredient for ContraPest, which has limited sources and must be in a very refined condition.

We currently have one source of triptolide, which, in a purified form, is a key ingredient for ContraPest. If we are unable to develop additional sources of triptolide our long-term ability to produce ContraPest at a cost-effective price or in desired quantities could be in jeopardy. If market demand for triptolide causes the price to increase beyond our ability to market at a competitive price or causes the quality of the refined ingredient to be less than needed for our production, our ability to commercialize ContraPest could be limited or delayed, which would adversely affect our business, results of operations and financial condition.

A variety of risks associated with marketing our product candidates internationally could materially adversely affect our business.

We plan to seek regulatory approval of our product candidates outside of the U.S. and, accordingly, we expect that we will be subject to additional risks related to operating in foreign countries if we obtain the necessary approvals, including:

These and other risks associated with our international operations may materially adversely affect our ability to attain or maintain profitable operations.

We are subject to anti-corruption and anti-money laundering laws with respect to our operations and noncompliance with such laws can subject us to criminal and/or civil liability and harm our business.

We are subject to the Foreign Corrupt Practices Act, or FCPA, the U.S. Travel Act, the USA PATRIOT Act and other anti-bribery and anti-money laundering laws in countries in which we conduct our business. Anti-corruption laws are interpreted broadly and prohibit companies and their employees and third-party intermediaries from authorizing, offering or providing, directly or indirectly, improper payments or benefits to recipients in the public or private sector. As we commercialize our product candidates and commence international sales and business, we may engage with collaborators and third-party intermediaries to sell our products internationally and to obtain necessary permits, licenses and other regulatory approvals. We or our third-party intermediaries may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities. We may be found liable for the corrupt or other illegal activities of these third-party intermediaries, our employees, representatives, contractors, partners and agents, even if we do not explicitly authorize such activities.

Noncompliance with anti-corruption and anti-money laundering laws could subject us to whistleblower complaints, investigations, sanctions, settlements, prosecution, other enforcement actions, disgorgement of profits, significant fines, damages, other civil and criminal penalties or injunctions, suspension and/or debarment from contracting with certain persons, the loss of export privileges, reputational harm, adverse media coverage and other collateral consequences. Responding to any action will likely result in a materially significant diversion of management’s attention and resources and significant defense costs and other professional fees, which could have a material adverse effect on our business, operating results or financial condition.

If we are unable to obtain or protect intellectual property rights, our competitive position could be harmed.

We depend on our ability to protect our proprietary technology. We rely on trade secret, patent, copyright and trademark laws, and confidentiality, licensing, and other agreements with employees and third parties, all of which offer only limited protection. Our commercial success will depend in part on our ability to obtain and maintain intellectual property protection in the United States and other countries with respect to our proprietary technology and products. Where we deem appropriate, we seek to protect our proprietary position by filing patent applications in the U.S. and internationally related to our novel technologies and products that are important to our business. Patent positions can be highly uncertain, involve complex legal and factual questions and be the subject of litigation. As a result, the issuance, scope, validity, enforceability, and commercial value of our patents, including those patent rights licensed to us by third parties, are highly uncertain.

The steps we have taken to protect our proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, both inside and outside the U.S. The rights already granted under any of our currently issued patents and those that may be granted under future issued patents may not provide us with the proprietary protection or competitive advantages we are seeking. If we are unable to obtain and maintain protection for our technology and products, or if the scope of the protection obtained is not sufficient, our competitors could develop and commercialize technology and products similar or superior to ours, and our ability to successfully commercialize our technology and products may be adversely affected.

With respect to patent rights, we do not know whether any of our pending patent applications for any of our technologies or products will result in the issuance of patents that protect such technologies or products, or if our licensed patent will effectively prevent others from commercializing competitive technologies and products. Our pending patent applications cannot be enforced against third parties practicing the technology claimed in such applications unless and until a patent issues from such applications. Further, the examination process may require us to narrow the claims for our pending patent applications, which may limit the scope of patent protection that may be obtained if these applications issue. Because the issuance of a patent is not conclusive as to its inventorship, scope, validity, or enforceability, issued patents that we own or have licensed from third parties may be challenged in the courts or patent offices in the U.S. and internationally. Such challenges may result in the loss of patent protection, the narrowing of claims in such patents, or the invalidity or unenforceability of such patents, which could limit our ability to stop others from using or commercializing similar or identical technology and products, or limit the duration of the patent protection for our technology and products. Protecting against the unauthorized use of our patented technology, trademarks, and other intellectual property rights, is expensive, difficult, and in some cases, may not be possible. In some cases, it may be difficult or impossible to detect third party infringement or misappropriation of our intellectual property rights, even in relation to issued patent claims, and proving any such infringement may be even more difficult.

Intellectual property rights do not necessarily address all potential threats to any competitive advantage we may have.

The degree of future protection afforded by our intellectual property rights is uncertain because intellectual property rights have limitations, and may not adequately protect our business, or permit us to maintain our competitive advantage. The following examples are illustrative:

Our technology may be found to infringe third party intellectual property rights.

Third parties may in the future assert claims or initiate litigation related to their patent, copyright, trademark and other intellectual property rights in technology that is important to us. The asserted claims and/or litigation could include claims against us, our licensors, or our suppliers alleging infringement of intellectual property rights with respect to our product candidates or components of those products. Regardless of the merit of the claims, they could be time consuming, resulting in costly litigation and diversion of technical and management personnel, or require us to develop noninfringing technology or enter into license agreements. We cannot assure you that licenses will be available on acceptable terms, if at all. Furthermore, because of the potential for significant damage awards, which are not necessarily predictable, it is not unusual to find even arguably unmeritorious claims resulting in large settlements. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop noninfringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially adversely affected.

If our product candidates, methods, processes, and other technologies infringe the proprietary rights of other parties, we could incur substantial costs and we may have to:

We may need to license intellectual property from third parties, and such licenses may not be available or may not be available on commercially reasonable terms.

A third party may hold intellectual property, including patent rights that are important or necessary to the development of our product candidates. It may be necessary for us to use the patented or proprietary technology of a third party to manufacture or otherwise commercialize our own technology or products, in which case we would be required to obtain a license from such third party. Licensing such intellectual property may not be available or may not be available on commercially reasonable terms, which could have a material adverse effect on our business, operating results and financial condition.

Risks Related to our Capital Stock

We have incurred significant operating losses every quarter since our inception and anticipate that we will continue to incur significant operating losses in the future.

Investment in product development is highly speculative because it entails substantial upfront capital expenditures and significant risk that any potential product candidate will fail to demonstrate adequate efficacy or an acceptable safety profile, gain regulatory approval, or become commercially viable. To date, we have financed our operations primarily through research grants as well as through the sale of equity securities and debt financings. Until August 2, 2016, we did not have any products approved by a regulatory authority for marketing or commercial sale, and we have generated minimal revenue from product sales to date. We continue to incur significant research, development, and other expenses related to our ongoing operations, including sales, marketing, and distribution functionality. As a result, we are not profitable and have incurred losses in every reporting period since our inception. For the years ended December 31, 2017 and 2016, we reported net losses of $12.3 million and $10.9 million, respectively. For the six months ended June 30, 2018 and the six months ended June 30, 2017, we reported net losses of $6.8 million and $7.0 million, respectively As of June 30, 2018, we had an accumulated deficit since inception of $80.4 million.

Since inception, we have dedicated a majority of our resources to the discovery and development of our proprietary product candidates. We expect to continue to incur significant expenses and operating losses for the foreseeable future. The size of our losses will depend, in part, on the rate of future expenditures and our ability to generate revenues. In particular, we expect to incur substantial and increased expenses as we:

We may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors that may adversely affect our financial condition. Our prior losses and expected future losses have had, and will continue to have, an adverse effect on our financial condition. If our product candidates do not gain sufficient regulatory approval, or if ContraPest fails to achieve market acceptance, we may never become profitable. Even if we achieve profitability in the future, we may not be able to sustain profitability in subsequent periods. Our failure to become and remain profitable would decrease the value of our company and could impair our ability to raise capital, expand our business, diversify our product offerings or continue our operations. A decline in the value of our company could cause you to lose all or part of your investment.

We may not be able to comply with all applicable listing requirements or standards of The Nasdaq Capital Market and Nasdaq could delist our common stock.

Our common stock is listed on the Nasdaq Capital Market. In order to maintain that listing, we must satisfy minimum financial and other continued listing requirements and standards. On January 3, 2018, we received a deficiency letter from the listing qualifications staff of the Nasdaq Stock Market, notifying us that, for the prior 30 consecutive business days, the closing bid price of our common stock was not maintained at the minimum required closing bid price of at least $1.00 per share as required for continued listing on the Nasdaq Capital Market. In accordance with Nasdaq Listing Rules, we had an initial compliance period of 180 calendar days, until July 2, 2018, to regain compliance with this requirement. On June 5, 2018, we received notice from the listing qualifications staff of the Nasdaq Stock Market, notifying us that the closing bid price of our common stock was greater than $1.00 per share for ten consecutive business days and that we had regained compliance with the minimum bid price requirement.

We cannot provide any assurance that our stock price will continue to satisfy the minimum bid price requirement or that we will be able to satisfy any other continued listing requirement of the Nasdaq Stock Market. In the event that our common stock is not eligible for quotation on another market or exchange, trading of our common stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate price quotations for, our common stock, and there would likely be a reduction in our coverage by security analysts and the news media, which could cause the price of our common stock to decline further. In addition, it may be difficult for us to raise additional capital if we are not listed on a major exchange.

If we are unable to continue as a going concern, our securities will have little or no value.

We have incurred operating losses since our inception, and we expect to continue to incur significant expenses and operating losses for the foreseeable future. If we encounter significant issues or delays in the commercialization of ContraPest, these prior losses and expected future losses could have an adverse effect on our financial condition, negatively impact our ability to fund continued operations, our ability to obtain additional financing in the future and our ability to continue as a going concern. There are no assurances that such financing, if necessary, will be available to us at all or will be available in sufficient amounts or on reasonable terms. Our financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we are unable to generate additional funds in the future through financings, sales of our products, licensing fees, royalty payments, or from other sources or transactions, we will exhaust our resources and will be unable to continue operations. If we cannot continue as a going concern, our stockholders would likely lose most or all of their investment in us.

Raising additional capital may cause dilution to our existing stockholders, restrict our operations, or require us to relinquish rights to our technologies or product candidates.

Until such time, if ever, as we can generate sufficient product revenues, we expect to finance our cash needs primarily through the sale of equity securities, debt financings, credit facilities and government and foundation grants. We may also seek to raise capital through third party collaborations, strategic alliances and similar arrangements. We currently do not have any committed external source of funds. Raising funds in the future may present additional challenges and future financing may not be available in sufficient amounts or on terms acceptable to us, if at all. The terms of any financing arrangements we enter into may adversely affect the holdings or the rights of our stockholders and the issuance of additional securities by us, or the possibility of such issuance, may cause the market price of our shares to decline. Certain of our outstanding warrants contain provisions that impose limitations on our ability to participate in certain variable rate transactions, including at-the-market transactions, which may limit our opportunities to obtain financing in sufficient amounts or on acceptable terms. The sale of additional equity or convertible debt securities would dilute all of our stockholders, and if such sales occur at a deemed issuance price that is lower than the current exercise price of our outstanding warrants sold to investors in November 2017, the exercise price for those warrants would adjust downward to the deemed issuance price pursuant to price adjustment protection contained within those warrants. The incurrence of indebtedness through credit facilities would result in increased fixed payment obligations and, potentially, the imposition of restrictive covenants. Those covenants may include limitations on our ability to incur additional debt, making capital expenditures or declaring dividends, and may impose limitations on our ability to acquire, sell, or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If we raise additional funds through collaborations, strategic alliances, or licensing arrangements or other marketing or distribution arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates, or grant licenses on terms that may not be favorable to us. If we are unable to expand our operations or otherwise capitalize on our business opportunities, our business, financial condition and results of operations could be materially adversely affected. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or commercialization efforts, or grant others rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

Our share price may be volatile, which could subject us to securities class action litigation and your investment in our securities could decline in value.

Our stock could be subject to wide fluctuation in response to many risk factors listed in this section, and others beyond our control, including:

Furthermore, the capital markets can experience extreme price and volume fluctuations that may affect the market prices of equity securities of many companies. These broad market and industry fluctuations, as well as general economic, political, and market conditions such as recessions, interest rate changes, or international currency fluctuations, may negatively impact the market price of shares of our common stock. In addition, such fluctuations could subject us to securities class action litigation, which could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business. You may not realize any return on your investment in us and may lose some or all of your investment.

An active market in the shares may not continue to develop in which investors can resell our common stock.

We cannot predict the extent to which an active market for our common stock will continue to develop or be sustained, or how the development of such a market might affect the market price for our common stock. Market conditions in effect at the time you acquire our stock may not be indicative of the price at which our common stock will trade in the future. Investors may not be able to sell their common stock at or above the price they acquired it.