Quarterly report pursuant to Section 13 or 15(d)

Warrants and Derivative Liabilities

v3.10.0.1
Warrants and Derivative Liabilities
6 Months Ended
Jun. 30, 2018
Warrants And Derivative Liabilities [Abstract]  
Warrants And Derivative Liabilities

3. Warrants and Derivative Liabilities

 

Warrants

 

There are significant judgments and estimates inherent in the determination of the fair value of the Company’s warrants. These judgments and estimates included the assumptions regarding its future operating performance, the time to completing a liquidity event and the determination of the appropriate valuation methods. If the Company had made different assumptions, the fair value of the warrants could have been significantly different. (See Note 2)

 

Warrants vested and outstanding as of June 30, 2018 are summarized as follows:

 

 

 

 

 

 

 

 

 

Amount

 

 

 

Exercise

 

 

Term

 

 

Issued and

 

Source

 

Price

 

 

(Years)

 

 

Outstanding

 

 

 

 

 

 

 

 

 

 

 

Pre 2015 Common Stock Warrants

 

$ 1.00

 

 

6-10

 

 

 

4,000,000

 

2015 Common Stock Warrants

 

$

1.15-$5.00

 

 

5-10

 

 

 

442,000

 

2015 Series B Financing

 

 

 

 

 

 

 

 

 

 

 

Common Stock Warrants to Series B Stockholders

 

$ 0.00

 

 

 

5

 

 

 

1,556,250

 

Placement Agent Warrants

 

$ 0.00

 

 

 

5

 

 

 

187,500

 

2016 Common Stock Warrants to Service Providers

 

$ 1.15

 

 

 

10

 

 

 

40,000

 

2016 Series C Placement Agent Warrants

 

$ 0.40

 

 

 

5

 

 

 

125,000

 

2017 Series D Placement Agent Warrants

 

$ 0.25

 

 

 

5

 

 

 

480,000

 

2017 Common Stock Warrants to Service Provider

 

$ 0.41

 

 

 

5

 

 

 

125,000

 

2018 Emerald Financing Warrants

 

$ 0.10

 

 

 

5

 

 

 

44,200,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total warrants vested and outstanding as of June 30, 2018

 

 

 

 

 

 

 

 

 

 

51,155,750

 

 

2018 Emerald Financing Warrants

In January and February 2018, the Company issued an aggregate of 40,800,000 and 3,400,000 fully vested common stock warrants to Emerald Health Sciences and an accredited investor, respectively, in conjunction with the Emerald Financing discussed below (See Note 4). The Company reviewed the warrants for liability or equity classification under the guidance of ASC 480-10, Distinguishing Liabilities from Equity, and concluded that these warrants should be classified as liabilities. See additional discussion below, Derivative Liabilities- Emerald Warrant Liability.

 

2017 Series D Placement Agent Warrants

In January 2017, the Company issued 480,000 warrants to purchase common stock to its investment banker in exchange for services rendered in conjunction with the Series D Preferred Stock financing. The warrants vested immediately and had an estimated fair value of $115,200 utilizing the Black-Scholes option pricing model, this amount was recorded to issuance costs for the six months ended June 30, 2017.

 

2017 Common Stock Warrants to Service Provider

In February 2017, the Company entered into an agreement with one of its investors to provide advisory services on all matters including financing in exchange for 125,000 common stock warrants. The warrants vested immediately and had an estimated fair value of $30,000 utilizing the Black-Scholes option pricing model, this amount was recorded to general and administrative expense during the six months ended June 30, 2017.

 

Derivative Liabilities

 

The following tables summarize the activity of derivative liabilities for the periods indicated:

 

 

 

 

 

Six Months Ended June 30, 2018

 

 

 

December 31,

2017 Fair

Value of

Derivative Liabilities

 

 

Fair Value of Derivative Liabilities Issued

 

 

Change in

Fair value of Derivative Liabilities

 

 

Reclassification

of Derivatives

to Equity

 

 

June 30,

2018 Fair

Value of

Derivative Liabilities

 

Emerald Financing - Warrant Liability

 

$ -

 

 

$ 10,424,634

 

 

$ (814,071 )

 

$ -

 

 

$ 9,610,563

 

Series B Warrant Liability

 

 

551,322

 

 

 

-

 

 

 

1,231,820

 

 

 

(1,301,866 )

 

 

481,276

 

Series B Preferred Stock Conversion Liability

 

 

6,715

 

 

 

-

 

 

 

-

 

 

 

(6,715 )

 

 

-

 

Total

 

$ 558,037

 

 

$ 10,424,634

 

 

$ 417,749

 

 

$ (1,308,581 )

 

$ 10,091,839

 

 

 

 

Six Months Ended June 30, 2017

 

 

 

December 31,

2016 Fair

Value of

Derivative Liabilities

 

 

Fair Value of
Derivative Liabilities Issued

 

 

Change in

Fair value of Derivative Liabilities

 

 

Reclassification

of Derivatives

to Equity

 

 

June 30,

2017 Fair

Value of

Derivative Liabilities

 

Series B Warrant Liability

 

$ 1,112,308

 

 

$ -

 

 

$ (38,998 )

 

$ -

 

 

$ 1,073,310

 

Series B Preferred Stock Conversion Liability

 

 

118,821

 

 

 

-

 

 

 

(88,532 )

 

 

(5,238

)

 

 

25,051

 

Total

 

$ 1,231,129

 

 

$ -

 

 

$ (127,530 )

 

$ (5,238

 

$ 1,098,361

 

 

Emerald Financing Warrant Liability

In January and February 2018, the Company issued 44,200,000 warrants to purchase common stock in conjunction with the Emerald Financing discussed above. The warrants vest immediately and have an exercise price of $0.10 per share with a term of five years and are exercisable in cash or through a cashless exercise provision. The warrants contain an anti-dilution protection feature provided to the investors if the Company subsequently issues or sells any shares of common stock, stock options, or convertible securities at a price less than the exercise price of $0.10. The exercise price is automatically adjusted down to the price of the instrument being issued. In addition, the warrants contain a contingent put option in the event that the Company undergoes a subsequent financing that results in a change in control. The warrant holders also have the right to participate in subsequent financing transactions on an as-if converted basis.

 

The Company reviewed the warrants for liability or equity classification under the guidance of ASC 480-10, Distinguishing Liabilities from Equity, and concluded that the warrants should be classified as a liability and re-measured to fair market value at the end of each reporting period. The Company also reviewed the warrants under ASC 815 Derivatives and Hedging/Contracts in Entity’s Own Equity and determined that the Warrants also meet the definition of a derivative. With the assistance of a third-party valuation specialist, the Company valued the warrant liabilities utilizing the Monte Carlo valuation method pursuant to the accounting guidance of ASC 820-10, Fair Value Measurements. On the closing dates, the Company estimated that the fair value of the warrants issued on January 19, 2018 and February 16, 2018 was $4.7 million and $5.7 million, respectively.

 

The warrant liabilities have been valued using Monte Carlo simulations conducted at the closing dates of January 19, 2018 and February 16, 2018 and at June 30, 2018 using the following assumptions:

 

 

 

June 30,

2018

 

 

At

issuance

 

Dividend yield

 

 

0.00 %

 

 

0.00 %

Volatility factor

 

 

70.00 %

 

 

70.00 %

Risk-free interest rate

 

2.70-2.71

%

 

2.45-2.6

%

Expected term (years)

 

4.55-4.63

 

 

 

5.0

 

Closing price per share of common stock

 

$ 0.28

 

 

$

0.29-0.30

 

 

Because fair value assigned to the warrants exceeded the proceeds received in the Emerald Financing, none of the consideration was allocated to common stock and the Company recorded an adjustment for the difference between the fair value of the warrant liabilities and the total proceeds received to other expense in the Condensed Consolidated Statements of Operations and Comprehensive Loss for the six months ended June 30, 2018 as follows:

 

 

 

Closing

 

 

 

 

 

 

January

2018

 

 

February

2018

 

 

Total

 

Proceeds from Emerald Financing

 

$ 1,500,000

 

 

$ 1,750,000

 

 

$ 3,250,000

 

Initial Fair Value of Emerald Financing Warrant Liability

 

 

4,717,211

 

 

 

5,707,423

 

 

 

10,424,634

 

Excess over proceeds adjustment

 

$ 3,217,211

 

 

$ 3,957,423

 

 

$ 7,174,634

 

 

In addition, because the aggregate proceeds were allocated to the fair value of the Emerald Financing Warrant Liability, issuance costs totaling $137,191 were charged to other expense for the six months ended June 30, 2018.

 

For the three months ended June 30, 2018 the Company recorded other expense of $1,504,529 related to the change in fair value of the Emerald Financing Warrant Liability included in the Statement of Operations and Other Comprehensive Loss.

 

Series B Warrant Liability

In conjunction with the Series B Preferred Stock financing, the Company issued 6,437,500 common stock warrants exercisable at a price of $1.15 per share, the warrants expire five years from the issuance date. The warrants were initially valued at $2,935,800 utilizing the Black-Scholes pricing model. The warrants are exercisable in cash or through a cashless exercise provision and contain certain cash redemption rights. The Series B warrants also had a “down-round” protection feature if the Company subsequently issued or sold any shares of common stock, stock options, or convertible securities at a price less than the current exercise price. The down round provision was triggered and automatically adjusted down to $0.10 on December 28, 2017, after the Company entered into the Secured Promissory Note for a convertible bridge loan (See Note 8) and again to $0.00 on January 19, 2018, as a result of the Emerald Financing. The strike price for these warrants is now permanently reset. However, because the remaining warrant holders still have certain cash redemption rights upon the occurrence of certain fundamental transactions, as defined in the Series B warrant agreements, the warrants continue to require liability classification.

 

The Company reviewed the classification of the warrants as liabilities or equity under the guidance of ASC 480-10, Distinguishing Liabilities from Equity, and concluded that the Series B warrants should be classified as a liability. The Company then applied the fair value allocation methodology for allocating the proceeds of $5.0 million received from the Series B financing between the conversion liability and the warrants with the residual amount being allocated to the preferred stock.

 

The Company utilized the Black Scholes Merton Option Pricing Model to compute the fair value of the warrants, the assumptions are outlined as follows:

 

 

 

As of

June 30,

2018

 

 

As of

December 31,

2017

 

Dividend yield

 

 

0.00 %

 

 

0.00 %

Volatility factor

 

 

70.00 %

 

 

70.00 %

Risk-free interest rate

 

2.536-2.537

%

 

1.947-1.949

%

Expected term (years)

 

2.14-2.16

 

 

2.64-2.65

 

Weighted-average fair value of warrants

 

$ 0.276

 

 

$ 0.086

 

 

In January 2018, 987,000 Series B warrants were exercised at a price of $0.10 resulting in cash proceeds to the Company of $98,700. Prior to exercise, these Series B Warrants were adjusted to fair market value using a Black Scholes Merton Option Pricing Model which considered the closing trading price on the exercise dates. From January 19, 2018 through June 30, 2018, 3,706,750 Series B warrants were exercised at a price of $0.00 for no consideration. Prior to exercise, these Series B Warrants were adjusted to fair market value using a Black Scholes Merton Option Pricing Model which considered the closing trading price on the exercise dates. Because the exercise price of these options had been reset to $0.00, the fair value derived from the valuation model equaled the market value of the Company’s common stock on the exercise dates. (See Note 4)

 

For the three months ended June 30, 2018 and 2017, the Company recorded other expense of $75,713 and $26,437, respectively, related to the change in fair value of the Series B Warrant Liability included in the Condensed Consolidated Statements of Operations and Other Comprehensive Loss.

 

Series B Preferred Stock Conversion Liability

On August 20, 2015, in connection with the Series B Preferred Stock financing, the Company bifurcated a conversion liability related to a down-round protection provided to the Series B investors. The value of this embedded derivative was determined utilizing a “with and without” method by valuing the preferred stock with and without the down round protection. During the first fiscal quarter of 2018, all of the remaining Series B Preferred Stock was converted to common stock (See Note 4) and as a result, the Series B conversion liability was reduced to zero. The reduction of this liability totaling $6,715 was recorded to equity for the six months ended June 30, 2018.