Quarterly report pursuant to Section 13 or 15(d)

Warrants and Derivative Liabilities

v3.20.2
Warrants and Derivative Liabilities
9 Months Ended
Sep. 30, 2020
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 include assumptions regarding the Company’s 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 September 30, 2020 are summarized as follows:

 

 

 

 

 

 

 

 

 

Number of

Warrants

 

 

 

Exercise

 

 

Term

 

 

Vested and

 

Source

 

Price

 

 

(Years)

 

 

Outstanding

 

Pre 2015 Common Stock Warrants

 

$ 1.00

 

 

6—10

 

 

 

1,110,000

 

2015 Common Stock Warrants

 

$

1.15—5.00

 

 

5—10

 

 

 

220,000

 

2016 Common Stock Warrants to Service Providers

 

$ 1.15

 

 

 

10

 

 

 

40,000

 

2016 Series C Common Stock Warrants to Placement Agent

 

$ 0.40

 

 

 

5

 

 

 

125,000

 

2017 Series D Common Stock Warrants to Placement Agent

 

$ 0.25

 

 

 

5

 

 

 

480,000

 

2017 Common Stock Warrants to Service Provider

 

$ 0.41

 

 

 

5

 

 

 

125,000

 

2018 Emerald Financing Warrants

 

$ 0.10

 

 

 

5

 

 

 

3,400,000

 

Emerald Multi-Draw Credit Agreement Warrants

 

$ 0.50

 

 

 

5

 

 

 

7,500,000

 

2019 Common Stock Warrants

 

$ 0.35

 

 

 

5

 

 

 

8,000,000

 

2020 Common Stock Warrants

 

$ 0.06

 

 

 

5

 

 

 

116,666,668

 

2020 Common Stock Warrants to Placement Agent

 

$ 0.075

 

 

 

4.99

 

 

 

8,166,667

 

2020 Pre-Funded Warrants

 

$ 0.001

 

 

indefinite

 

 

 

49,800,000

 

Total warrants vested and outstanding as of September 30, 2020

 

 

 

 

 

 

 

 

 

 

195,633,335

 

 

Emerald Multi-Draw Credit Agreement Warrants

 

During the nine months ended September 30, 2019, the Company issued 5,000,000 fully vested common stock warrants to Emerald Health Sciences, in conjunction with advances under the Credit Agreement discussed below (See Note 4). The warrants were equity classified at issuance and the Company allocated an aggregate of $716,110 of the gross proceeds to the warrants on a relative fair value basis. The proceeds allocated to the warrants were recorded as discounts to each advance and are being amortized over the term of the debt. The warrants vested immediately and had an estimated aggregate fair value of $1,830,573 utilizing the Black-Scholes Merton option pricing model with the following assumptions:

 

 

 

 

At

Issuance

 

Dividend yield

 

0.00%

 

Volatility factor

 

91.6—92.1

 

Risk-free interest rate

 

2.23—2.51

 

Expected term (years)

 

5.0

 

Underlying common stock price

 

$0.33—0.69

 

 

August 2020 Financing Warrants

 

In connection with the August 2020 Financing (Note 5), the Company issued 116,666,668 common stock warrants, 8,166,667 common stock warrants to the placement agent and 60,333,334 pre-funded warrants. The warrants were equity classified at issuance and the Company allocated $2,462,462 and $2,986,500 of the gross proceeds to the common stock warrants and pre-funded warrants on a relative fair value basis, respectively. The common stock warrants issued to the placement agent were valued at $261,333 and recorded as equity issuance costs within equity. The warrants vested immediately and were valued utilizing the Black-Scholes Merton option pricing model with the following assumptions:

 

 

 

Common Stock Warrants

 

 

Pre-funded

Warrants

 

 

Placement Agent Warrants

 

Dividend yield

 

 

0.00 %

 

 

0.00 %

 

 

0.00 %

Volatility factor

 

 

91.64 %

 

 

93.86 %

 

 

91.64 %

Risk-free interest rate

 

 

0.19 %

 

 

0.52 %

 

 

0.19 %

Expected term (years)

 

 

5.0

 

 

 

10

 

 

 

4.99

 

Underlying common stock price

 

$ 0.05

 

 

$ 0.05

 

 

$ 0.05

 

 

Derivative Liabilities

 

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

 

 

 

Nine Months Ended September 30, 2020

 

 

 

December 31,

2019,

Fair

Value of

Derivative Liabilities

 

 

Fair

Value of

Derivative Liabilities Issued

 

 

Change in

Fair value of

Liabilities

 

 

Reclassification

of Derivatives

to Equity

 

 

September 30,

2020,

Fair

Value of

Derivative Liabilities

 

Emerald Multi-Draw Credit Agreement - compound derivative liability (1)

 

$ 90,797

 

 

$

 

 

$ (90,797 )

 

$

 

 

$

 

Emerald Financing - warrant liability (2)

 

 

276,024

 

 

 

 

 

 

(234,875 )

 

 

 

 

 

41,149

 

Series B - warrant liability (3)

 

 

134,579

 

 

 

 

 

 

(108,016 )

 

 

(26,563 )

 

 

 

Total derivative liabilities

 

$ 501,400

 

 

$

 

 

$ (433,688 )

 

$ (26,563 )

 

$ 41,149

 

Less, noncurrent portion of derivative liabilities

 

 

(90,797 )

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current balance of derivative liabilities

 

$ 410,603

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ 41,149

 

   

 

 

Nine Months Ended September 30, 2019

 

 

 

December 31,

2018,

Fair

Value of

Derivative Liabilities

 

 

Fair

Value of

Derivative Liabilities

Issued

 

 

Change in

Fair

value of

Derivative Liabilities

 

 

Reclassification

of Derivatives

to Equity

 

 

September 30,

2019,

Fair

Value of

Derivative Liabilities

 

Emerald Multi Draw Credit Agreement - compound derivative liability (1)

 

$ 219,453

 

 

$ 516,058

 

 

$ (167,905 )

 

$

 

 

$ 567,606

 

Emerald Financing - warrant liability (2)

 

 

15,251,413

 

 

 

 

 

 

(1,895,193 )

 

 

 

 

 

13,356,220

 

Series B - warrant liability (3)

 

 

487,500

 

 

 

 

 

 

38,438

 

 

 

(144,375 )

 

 

381,563

 

Total derivative liabilities

 

$ 15,958,366

 

 

$ 516,058

 

 

$ (2,024,660 )

 

$ (144,375 )

 

$ 14,305,389

 

Less, noncurrent portion of derivative liabilities

 

 

(219,453 )

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(567,606 )

Current balance of derivative liabilities

 

$ 15,738,913

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ 13,737,783

 

 

 

    

Emerald Multi-Draw Credit Agreement Compound Derivative Liability (1)

 

In connection with the advances under the Credit Agreement (See Note 4), the Company bifurcated a compound derivative liability related to a contingent interest feature and acceleration upon default provision (contingent put option) provided to Emerald Health Sciences. The Company’s estimate of fair value of the compound derivative liability was determined by using a differential cash flows valuation model, wherein the fair value of the underlying debt facility and its conversion right are estimated both with and without the presence of the contingent interest feature, holding all other assumptions constant. The resulting difference between the estimated fair values in both scenarios is the estimated fair value of the compound derivative. The fair value of the underlying debt facility was estimated by calculating the expected cash flows with consideration of the estimated probability of a change in control transaction, defined as an event of default by the agreement, and applying the expected default interest rate from the date of such default through maturity. The expected cash flows are then discounted back to the reporting date using a benchmark market yield. The conversion right component of the compound derivative was measured using a standard Black-Scholes model for each payment period.

 

On April 29, 2020, the Company entered into the Amended Credit Agreement which removed the change in control provision as an event of default for advances before and after the amendment. As a result of the modification, the contingent interest feature component of the compound derivative is no longer required to be bifurcated as a derivative liability. During the nine months ended September 30, 2020, the liability has been reduced to $0 through an adjustment to the change in fair value of derivative liabilities.

 

Because Emerald Health Sciences would forgo the contingent interest if the contingent put option was exercised upon an event of default, the value ascribed to the contingent put option within the compound derivative is considered de minimis before and after the amendment to the Credit Agreement.

 

Emerald Financing Warrant Liability (2)

 

In January and February 2018, the Company issued 44,200,000 warrants to purchase common stock in conjunction with the Emerald Financing. 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 contained an anti-dilution protection feature that provided the investors with price protection if the Company subsequently issued or sold any shares of common stock, stock options, or convertible securities at a price less than the exercise price of $0.10. In connection with the August 2020 Financing, this provision was waived, and the exercise price was permanently set to $0.10. In addition, the warrants contain a contingent put option if 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.

 

In December 2019, Emerald Health Sciences paid the aggregate exercise price of $4,080,000 in the form of a reduction of the corresponding amount of obligations outstanding under the Credit Agreement to exercise 40,800,000 Emerald Financing Warrants. Under the Warrant Exercise Agreement between the Company and Emerald Health Sciences, the proceeds from the warrants were first applied directly to the accrued interest balance at the exercise date with the remainder applied to the oldest outstanding principal balances under the Credit Agreement. Immediately prior to exercise, the warrants were adjusted to fair value which considered the closing trading price on the exercise date (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 the warrants should be classified as a liability and re-measured to fair value at the end of each reporting period. The Company also reviewed the warrants under ASC 815, Derivatives and Hedging/Contracts in Entitys 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.

 

The warrant liabilities were valued using Monte Carlo simulations conducted at the balance sheet dates using the following assumptions:

 

 

 

 

September 30,

2020

 

 

December 31,

2019

 

Dividend yield

 

 

0.00 %

 

 

0.00 %

Volatility factor

 

 

80.8 %

 

 

79.5 %

Risk-free interest rate

 

 

0.14 %

 

 

1.62 %

Expected term (years)

 

 

2.38

 

 

 

3.13

 

Underlying common stock price

 

$ 0.04

 

 

$ 0.13

 

 

 

Series B Warrant Liability (3)

 

In conjunction with the Redeemable Convertible Series B Preferred Stock financing, the Company issued the 2015 Series B Financing Warrants originally exercisable at a price of $1.15 per share. The warrants are exercisable in cash or through a cashless exercise provision and contain certain cash redemption rights. The Series B Financing 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 Convertible Promissory Note (See Note 4) 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 had certain cash redemption rights upon the occurrence of certain fundamental transactions, as defined in the Series B Financing Warrant agreements, the warrants continued to require liability classification. Subsequent to the repricing that occurred as a result of the Emerald Financing, the warrants have been valued using a Black Scholes Merton Option Pricing Model.

 

To compute the fair value of the warrants, the Company utilized the following assumptions in the Black Scholes Merton Option Pricing Model for the periods indicated:

 

 

 

As of

December 31,

2019

 

Dividend yield

 

 

0.00 %

Volatility factor

 

 

79.2 %

Risk-free interest rate

 

 

1.60 %

Expected term (years)

 

 

0.64

 

Underlying common stock price

 

$ 0.13

 

 

During the nine months ended September 30, 2020, 312,500 Series B Common Stock Warrants with an intrinsic value of $26,563 were exercised for no consideration per share, which resulted in the issuance of 312,500 shares of common stock. Prior to exercise, these Series B Common Stock Warrants were adjusted to fair 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 approximated the market value of the Company’s common stock on the exercise dates.

 

As of September 30, 2020, the remaining Series B Common Stock Warrants expired unexercised.