NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Timber Pharmaceuticals, Inc., formerly known as BioPharmX Corporation, (together with its subsidiary the “Company” or “Timber”) is incorporated under the laws of the state of Delaware and originally incorporated on August 30, 2010 in Nevada under the name Thompson Designs, Inc. The Company has one wholly-owned subsidiary, BioPharmX, Inc., a Nevada corporation. The Company is a specialty pharmaceutical company focused on the dermatology market. Its focus is to develop products that treat dermatologic conditions that are not being adequately addressed or those where current therapies and approaches are suboptimal. Its strategy is to bring new products to market by identifying optimal delivery mechanisms and/or alternative applications for United States Food and Drug Adminstration (“FDA”) approved or well characterized active pharmaceutical ingredients (“API”). The Company aims to reduce the time, cost and risks typically associated with new product development by utilizing APIs with demonstrated safety profiles and, when applicable, taking advantage of the regulatory approval pathway under Section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act. Section 505(b)(2) permits an applicant for a new product, such as a new or improved formulation or a new use of an approved product, to rely in part on literature and/or the FDA’s findings of safety and/or effectiveness for a similar previously-approved product. The Company’s approach is to identify the limitations of current treatment options and work to develop novel products using our proprietary HyantX™ topical drug delivery system.

Since the Company’s inception, substantially all of the Company’s efforts have been devoted to developing its product candidates, including conducting preclinical and clinical trials, and providing general and administrative support for its operations. The Company has financed its operations primarily through the sale of equity and convertible notes.

Merger Agreement

On May 18, 2020, the Company completed its business combination with Timber Pharmaceuticals LLC, a Delaware limited liability company (“Timber Sub”), in accordance with the terms of the Agreement and Plan of Merger and Reorganization, dated as of January 28, 2020 (the “Merger Agreement”), by and among the Company, Timber Sub and BITI Merger, Inc., a Delaware corporation and wholly-owned subsidiary of the Company (“Merger Sub”), as amended by Amendment No. 1 thereto made and entered into as of March 24, 2020 (the “First Amendment”) and Amendment No. 2 thereto made and entered into as of April 27, 2020 (the “Second Amendment”) (the Merger Agreement, as amended by the First Amendment and the Second Amendment, the “Amended Merger Agreement”), pursuant to which Merger Sub merged with and into Timber Sub, with Timber Sub surviving as a wholly-owned subsidiary of the Company (the “Merger”). In connection with, and immediately prior to the completion of, the Merger, the Company effected a reverse stock split of the Company’s common stock, par value $0.001 per share (the “Common Stock”), at a ratio of 1-for-12 (the “Reverse Stock Split”). Immediately after completion of the Merger, the Company changed its name to “Timber Pharmaceuticals, Inc.”, focused on the development and commercialization of treatments for orphan dermatologic diseases.

Under the terms of the Amended Merger Agreement, the Company issued shares of Common Stock to the holders of common units of Timber Sub. Immediately after the Merger, there were approximately 11,867,904 shares of Common Stock outstanding (after the Reverse Stock Split). Pursuant to the terms of the Amended Merger Agreement, the former holders of common units of Timber Sub (including the Investors, as defined below, but excluding VARs, as defined below) owned in the aggregate approximately 88.5% of the outstanding Common Stock, with the Company’s stockholders immediately prior to the Merger owning approximately 11.5% of the outstanding Common Stock. The number of shares of Common Stock issued to the holders of common units of Timber Sub for each common unit of Timber Sub outstanding immediately prior to the Merger was calculated using an exchange ratio of approximately 629.57 shares of Common Stock for each Timber Sub unit. In addition, the 584 Value Appreciation Rights of Timber Sub (“VARs”) that were outstanding immediately prior to Merger became denoted and payable in 367,670 shares of Common Stock at the Effective Time. Further, the holder of the 1,820,046 preferred units of Timber Sub outstanding immediately prior to the Merger received 1,821 shares of the newly created convertible Series A preferred stock at the effective time of the Merger (the “Effective Time”).

In connection with the Merger Agreement, the Company entered into a Credit Agreement with Timber Sub, pursuant to which Timber Sub has agreed to make a bridge loan to the Company (the “Bridge Loan”), in an aggregate amount of $2.25 million with $250,000 original issue discount. As of April 30, 2020, the Company had received $1,250,000 under the Bridge Loan with the remaining $1,000,000 received on May 18, 2020.

Securities Purchase Agreement

On May 18, 2020, the Company and Timber Sub completed a previously announced private placement transaction with certain accredited investors for an aggregate purchase price of approximately $25.0 million (comprised of (x) approximately $5 million credit with respect to the senior secured notes issued in connection with the bridge loan that certain of the Investors made to Timber Sub at the time of the execution of the Merger Agreement, and (y) approximately $20 million in cash from the Investors, whereby, among other things, Timber Sub issued to the Investors common units of Timber Sub immediately prior to the Merger (the “Pre-Merger Financing”), pursuant to the Securities Purchase Agreement (the “Securities Purchase Agreement”), made and entered into as March 27, 2020, as amended, by and among the Company, Timber Sub and the institutional investors party thereto (the “Investors”). 

In addition, pursuant to the terms of the Securities Purchase Agreement, dated as of January 28, 2020 between Timber Sub and several of the Investors (the “Bridge Investors”), the Company issued to the Bridge Investors, on May 22, 2020, warrants to purchase 413,751 shares of Common Stock at an exercise price of $2.2362.

Investor Warrants

On June 2, 2020, pursuant to the terms of the Securities Purchase Agreement, the Company issued the Series A Warrants, the Series B Warrants and the Bridge Warrants.

Series A Warrants

The Series A Warrants were issued on June 2, 2020 at an initial exercise price of $2.7953 per share, were immediately exercisable upon issuance and have a term of five years from the date of issuance. The Series A Warrants are exercisable for 8,384,764 shares of Common Stock in the aggregate.

The Series A Warrants provide that if the Company issues or sells, enters into a definitive, binding agreement pursuant to which the Company is required to issue or sell or is deemed, pursuant to the provisions of the Series A Warrants, to have issued or sold, any shares of Common Stock for a price per share lower than the exercise price then in effect (a “Dilutive Issuance”), subject to certain limited exceptions, then the exercise price of the Series A Warrants shall be reduced to such lower price per share. Notwithstanding the foregoing, no adjustment to the exercise price of the Series A Warrants as a result of a Dilutive Issuance shall cause the exercise price to be less than $1.2085, calculated based on a pre-money valuation (of the combined company, assuming for this purpose the pre-money issuance of the Converted Shares) of $15 million.

In addition, the exercise price and the number of shares of Common Stock issuable upon exercise of the Series A Warrants are subject to adjustment in connection with stock splits, dividends or distributions or other similar transactions. Further, on each Reset Date (as defined below) the Series A Warrants will be adjusted downward (but not increased) such that the exercise price thereof becomes 125% of the Reset Price (as defined below), and the number of shares underlying the Series A Warrants will be increased (but not decreased) to the quotient of (a)(i) the exercise price in effect prior to the Reset (as defined below) multiplied by (ii) the number of shares underlying the Series A Warrants prior to the Reset divided by (b) the exercise price resulting from the Reset.

Pursuant to the Series A Warrants, the Company has agreed not to enter into, allow or be party to certain fundamental transactions, generally including any merger with or into another entity, sale of all or substantially all of the Company’s assets, tender offer or exchange offer, or reclassification of the Common Stock (a “Fundamental Transaction”) until the 45th trading day immediately following the earlier to occur of (x) the date a holder can sell all underlying securities pursuant to Rule 144 without restriction or limitation and without the requirement to be in compliance with Rule 144(c)(1) of the Securities Act and (y) June 2, 2022 (the “Reservation Date”). Thereafter, upon any exercise of a Series A Warrant, the holder shall have the right to receive, for each share of Common Stock that would have been issuable upon such exercise immediately prior to the occurrence of a Fundamental Transaction, at the option of the holder (without regard to any limitation on the exercise of the Series A Warrant), the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which the Series A Warrant is exercisable immediately prior to such Fundamental Transaction (without regard to any limitation on the exercise of the Series A Warrant). For purposes of any such exercise, the determination of the exercise price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the exercise price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of the Series A Warrant following such Fundamental Transaction. The Company shall cause any successor entity in a Fundamental Transaction in which the Company is not the survivor (the “Successor Entity”) to assume in writing all of the obligations of the Company under the Series A Warrants, upon which the Series A Warrants shall become exercisable for shares of Common Stock, shares of the common stock of the Successor Entity or the consideration that would have been issuable to the holders had they exercised the Series A Warrants prior to such Fundamental Transaction, at the holders’ election.

Additionally, at the request of a holder delivered before the 90th day after the consummation of a Fundamental Transaction, the Company or the successor entity must purchase such holder’s warrant for the value calculated using the Black-Scholes option pricing model as of the day immediately following the public announcement of the applicable Fundamental Transaction, or, if the Fundamental Transaction is not publicly announced, the date the Fundamental Transaction is consummated.

The Series A Warrants also contain a “cashless exercise” feature that allows the holders to exercise the Series A Warrants without making a cash payment in the event that there is no effective registration statement registering the shares issuable upon exercise of the Series A Warrants. The Series A Warrants are subject to a blocker provision which restricts the exercise of the Series A Warrants if, as a result of such exercise, the holder, together with its affiliates and any other person whose beneficial ownership of Common Stock would be aggregated with the holder’s for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) would beneficially own in excess of 4.99% or 9.99% of the outstanding Common Stock (including the shares of Common Stock issuable upon such exercise), as such percentage ownership is determined in accordance with the terms of the Series A Warrants.

If the Company fails to issue to a holder of Series A Warrants the number of shares of Common Stock to which such holder is entitled upon such holder’s exercise of the Series A Warrants, then the Company shall be obligated to pay the holder on each day while such failure is continuing an amount equal to 1.5% of the market value of the undelivered shares determined using a trading price of Common Stock selected by the holder while the failure is continuing and if the holder purchases shares of Common Stock in connection with such failure (“Series A Buy-In Shares”), then the Company must, at the holder’s discretion, reimburse the holder for the cost of such Series A Buy-In Shares or deliver the owed shares and reimburse the holder for the difference between the price such holder paid for the Series A Buy-In Shares and the market price of such shares, measured at any time of the holder’s choosing while the delivery failure was continuing.

Further, in the event that the Company does not have sufficient authorized shares to deliver in satisfaction of an exercise of a Series A Warrant, then unless the holder elects to void such attempted exercise, the holder may require the Company to pay an amount equal to the product of (i) the number of shares that the Company is unable to deliver and (ii) the highest volume-weighted average price of a share of Common Stock as quoted on NYSE American during the period beginning on the date of such attempted exercise and ending on the date that the Company makes the applicable payment.

Series B Warrants

The Series B Warrants have an exercise price of $0.001, were exercisable upon issuance and will expire on the day following the later to occur of (i) the Reservation Date, and (ii) the date on which the Investor’s Series B Warrants have been exercised in full (without giving effect to any limitation on exercise contained therein) and no shares remain issuable thereunder. Upon their issuance on June 2, 2020, the Series B Warrants were exercisable for 7,042,175 shares of Common Stock in the aggregate.

Additionally, every ninth trading day up to and including the 45th trading day (each, a “Reset Date”) following (i) the 15th trading day immediately following the issuance date of the Series B Warrants and (ii) every 15th trading day thereafter (each such date provided in the foregoing clauses (i) and (ii), an “End Reset Measuring Date”) (except if on such date (1) the holder cannot freely sell any Registrable Securities (as defined below) pursuant to a resale registration statement and (2) the holder cannot sell any Registrable Securities without restriction or limitation pursuant to Rule 144, and provided that no date following the occurrence of a Satisfaction Event (as defined below) will be deemed an End Reset Measuring Date, and provided further that no such date will be deemed an End Reset Measuring Date if an End Reset Measuring Date has previously occurred and either (1) if the holder was able to then freely sell any Registrable Securities pursuant to a resale registration statement in accordance with such prior End Reset Measuring Date, such ability continued uninterrupted through and including the applicable date of determination or (2) if the holder was able to freely sell any Registrable Securities without restriction or limitation pursuant to Rule 144 in accordance with such prior End Reset Measuring Date, such ability continued uninterrupted through and including the applicable date of determination) (such 45 trading day period, the “Reset Period” and each such 45th trading day after (i) or (ii), the “End Reset Date”), the number of shares issuable upon exercise of each Investor’s Series B Warrants shall be increased (a “Reset”) to the number (if positive) obtained by subtracting (i) the number of Converted Shares, from (ii) the quotient determined by dividing (a) the pro rata portion of the Purchase Price paid by the Investor, by (b) the greater of (x) the arithmetic average of the five lowest dollar volume-weighted average prices of a share of Common Stock on NYSE American during the applicable Reset Period immediately preceding the applicable Reset Date to date and (y) provided that the Common Stock is then traded on the NYSE American, a floor price per share of $0.8056 (the “Floor Price”) calculated based on a pre-money valuation (of the combined company, assuming for this purpose the pre-money issuance of the Converted Shares) of $10 million (such number resulting in this clause (b), the “Reset Price”). “Satisfaction Event” means (1) all Registrable Securities are able to be freely sold without any restriction or limitation by the holder at all times during the 45 trading day period beginning on, and including, any End Reset Measuring Date either (a) pursuant to a resale registration statement or (b) pursuant to Rule 144; or (2) the Reservation Date has occurred.

Pursuant to the Series B Warrants, the Company has agreed not to enter into, allow or be party to a Fundamental Transaction until the Reservation Date. Thereafter, upon any exercise of a Series B Warrant, the holder shall have the right to receive, for each share of Common Stock that would have been issuable upon such exercise immediately prior to the occurrence of a Fundamental Transaction, at the option of the holder (without regard to any limitation on the exercise of the Series B Warrant), the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which the Series B Warrant is exercisable immediately prior to such Fundamental Transaction (without regard to any limitation on the exercise of the Series B Warrant). For purposes of any such exercise, the determination of the exercise price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the exercise price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of the Series B Warrant following such Fundamental Transaction. The Company shall cause any Successor Entity to assume in writing all of the obligations of the Company under the Series B Warrants, upon which the Series B Warrants shall become exercisable for shares of Common Stock, shares of the common stock of the Successor Entity or the consideration that would have been issuable to the holders had they exercised the Series B Warrants prior to such Fundamental Transaction, at the holders’ election.

The Series B Warrants also contain a “cashless exercise” feature that allows the holders to exercise the Series B Warrants without making a cash payment. The Series B Warrants are subject to a blocker provision which restricts the exercise of the Series B Warrants if, as a result of such exercise, the holder, together with its affiliates and any other person whose beneficial ownership of Common Stock would be aggregated with the holder’s for purposes of Section 13(d) of the Exchange Act would beneficially own in excess of 4.99% or 9.99% of the outstanding Common Stock (including the shares of Common Stock issuable upon such exercise), as such percentage ownership is determined in accordance with the terms of the Series B Warrants.

If the Company fails to issue to a holder of Series B Warrants the number of shares of Common Stock to which such holder is entitled upon such holder’s exercise of the Series B Warrants, then the Company shall be obligated to pay the holder on each day while such failure is continuing an amount equal to 1.5% of the market value of the undelivered shares determined using a trading price of Common Stock selected by the holder while the failure is continuing and if the holder purchases shares of Common Stock in connection with such failure (“Series B Buy-In Shares”), then the Company must, at the holder’s discretion, reimburse the holder for the cost of such Series B Buy-In Shares or deliver the owed shares and reimburse the holder for the difference between the price such holder paid for the Series B Buy-In Shares and the market price of such shares, measured at any time of the holder’s choosing while the delivery failure was continuing.

Further, the Series B Warrants provide that, in the event that the Company does not have sufficient authorized shares to deliver in satisfaction of an exercise of a Series B Warrant, then unless the holder elects to void such attempted exercise, the holder may require the Company to pay an amount equal to the product of (i) the number of shares that is unable to deliver and (ii) the highest volume-weighted average price of a share of Common Stock as quoted on NYSE American during the period beginning on the date of such attempted exercise and ending on the date that the Company makes the applicable payment.

Bridge Warrants

The Bridge Warrants, were issued on May 22, 2020 to the Bridge Investors, have an exercise price of $2.2362 per share, were immediately exercisable upon issuance and have a term of five years from the date of issuance. The Bridge Warrants are exercisable for 413,751 shares of Common Stock in the aggregate.

The  Bridge Warrants provide that if Timber issues or sells or in accordance with the terms of the Bridge Warrants, is deemed to have issued or sold any shares of Common Stock for a price per share lower than the exercise price then in effect subject to certain limited exceptions, then the exercise price of the Bridge Warrants shall be reduced to such lower price per share.

Upon the consummation of Fundamental Transaction by the Company, upon any exercise of a Bridge Warrant, the holder shall have the right to receive, for each share of Common Stock that would have been issuable upon such exercise immediately prior to the occurrence of a Fundamental Transaction, at the option of the holder (without regard to any limitation on the exercise of the Bridge Warrant), the number of shares of Common Stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and any additional consideration (the “Alternate Consideration”) receivable as a result of such Fundamental Transaction by a holder of the number of shares of Common Stock for which the Bridge Warrant is exercisable immediately prior to such Fundamental Transaction (without regard to any limitation on the exercise of the Bridge Warrant). For purposes of any such exercise, the determination of the exercise price shall be appropriately adjusted to apply to such Alternate Consideration based on the amount of Alternate Consideration issuable in respect of one share of Common Stock in such Fundamental Transaction, and the Company shall apportion the exercise price among the Alternate Consideration in a reasonable manner reflecting the relative value of any different components of the Alternate Consideration. If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Fundamental Transaction, then the holder shall be given the same choice as to the Alternate Consideration it receives upon any exercise of the Bridge Warrant following such Fundamental Transaction. The Company shall cause any Successor Entity to assume in writing all of the obligations of the Company under the Bridge Warrants, upon which the Bridge Warrants shall become exercisable for shares of Common Stock, shares of the Common Stock of the Successor Entity or the consideration that would have been issuable to the holders had they exercised the Bridge Warrants prior to such Fundamental Transaction, at the holders’ election.

Additionally, at the request of a holder of a Bridge Warrant delivered before the 90th day after the consummation of a Fundamental Transaction, Timber or the successor entity must purchase such holder’s warrant for the value calculated using the Black-Scholes option pricing model as of the day immediately following the public announcement of the applicable Fundamental Transaction, or, if the Fundamental Transaction is not publicly announced, the date the Fundamental Transaction is consummated.

The Bridge Warrants also contain a “cashless exercise” feature that allows the holders to exercise the Bridge Warrants without making a cash payment in the event that there is no effective registration statement registering the shares issuable upon exercise of the Bridge Warrants. The Bridge Warrants are subject to a blocker provision which restricts the exercise of the Bridge Warrants if, as a result of such exercise, the holder, together with its affiliates and any other person whose beneficial ownership of Common Stock would be aggregated with the holder’s for purposes of Section 13(d) of the Exchange Act would beneficially own in excess of 4.99% or 9.99% of the outstanding shares of Common Stock (including the shares of Common Stock issuable upon such exercise), as such percentage ownership is determined in accordance with the terms of the Bridge Warrants.

Basis of Presentation and Principles of Consolidation

These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended January 31, 2020, filed on March 23, 2020. The condensed consolidated balance sheet as of January 31, 2020, included herein, was derived from the audited consolidated financial statements as of that date.

The unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary and have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s statement of financial position as of April 30, 2020 and January 31, 2020, and the Company’s results of operations and cash flows for the three months ended April 30, 2020 and 2019. The results for the three months ended April 30, 2020 are not necessarily indicative of the results to be expected for the year ending January 31, 2021 or any future period.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of expenses recognized during the reported period. Actual results could differ from those estimates.

Reverse Stock Split On May 18, 2020, immediately prior to the Merger, the Company effected a 1-for-12 reverse stock split of its Common Stock by filing an amendment to the Certificate of Incorporation with the Secretary of State of the State of Delaware to effect the Reverse Stock Split. As of the opening of the NYSE American on May 19, 2020, the Common Stock began trading on a Reverse Stock Split-adjusted basis. All common share numbers in this periodic report have been adjusted to reflect the Reverse Stock Split. As a result of the Reverse Stock Split, the number of issued and outstanding shares of Common Stock immediately prior to the Reverse Stock Split was reduced into a smaller number of shares, such that every 12 shares of Common Stock held by a stockholder of the Company immediately prior to the Reverse Stock Split were combined and reclassified into one share of Common Stock after the Reverse Stock Split. All outstanding and unexercised stock option and warrants to purchase shares of Common Stock otherwise remain in effect pursuant to their terms, subject to adjustment to account for the Reverse Stock Split. Immediately following the Reverse Stock Split, there were approximately 1,367,326 shares of Common Stock outstanding prior to the Merger. No fractional shares were issued in connection with the Reverse Stock Split. Stockholders who otherwise would be entitled to receive fractional shares instead are entitled to receive cash in lieu of their fractional shares.

The Reverse Stock Split had no effect on the par value of the Common Stock, or the rights and privileges of the holders of Common Stock or preferred stock, and did not affect any stockholder’s percentage ownership interest in the Company, except to the extent that it resulted in any stockholders owning a fractional share. As approved by the Company’s stockholders, the Reverse Stock Split made no corresponding adjustment with respect to the Company’s authorized capital stock.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. When such an event occurs, management determines whether there has been an impairment by comparing the anticipated undiscounted future net cash flows to the related asset’s carrying value. If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash flows or appraised value, depending on the nature of the asset. The Company did not identify any impairment losses for either of the three months ended April 30, 2020 or 2019.

Net Loss per Share

Basic net loss per share is calculated based on the weighted-average number of shares of the Company’s Common Stock outstanding during the period. The weighted-average shares outstanding for the three months ended April 30, 2020 and 2019 excludes 644 shares of unvested restricted Common Stock. Diluted net loss per share is calculated based on the weighted average number of shares of the Company’s Common Stock outstanding and other dilutive securities outstanding during the period.

As of April 30, 2020 and 2019, approximately 319,000 and 450,000 of potentially dilutive securities, respectively, were excluded from the computation of diluted net loss per share because their effect on net loss per share would be anti-dilutive.

Warrant Liability

The Company accounts for certain of its warrants as derivative liabilities based on provisions relating to cash settlement options. The Company recorded a liability for the fair value of the warrants at the time of issuance, and at each reporting date the warrants are revalued to the instrument’s fair value. The fair value of the warrants are estimated using the Black-Scholes pricing model. This liability is subject to fair value re-measurement until the warrants are exercised or expired, and any change in fair value is recognized as other income or expense in the condensed consolidated statements of operations and comprehensive loss.

Common Stock Liability

In January 2020, the Company entered into an exchange agreement with certain warrant holders, in which approximately 189,205 warrants to purchase shares of common stock was exchanged for 70,833 shares of Common Stock. The value of these shares was approximately $383,000 as of January 31, 2020 and was included in accrued expenses and other on the condensed consolidated balance sheets. The shares were issued in February 2020 at which time the related liability was remeasured and approximately $35,000 of income was recognized. The remaining $348,000 was reclassified to additional paid-in capital upon issuance of the shares. There was no common stock liability as of April 30, 2020.

Summary of Significant Accounting Policies

There have been no significant changes in the Company’s significant accounting policies for the three months ended April 30, 2020 as compared to the significant accounting policies described in the Annual Report on Form 10-K for the fiscal year ended January 31, 2020.

Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-13, Fair Value Measurement Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which amended certain disclosure requirements over Level 1, Level 2 and Level 3 fair value measurements. The amendment is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The Company adopted this update as of February 1, 2020 and the adoption did not have a material effect on its condensed consolidated financial statements.              

The Company has reviewed other recent accounting pronouncements and concluded they are either not applicable to the business or no material effect is expected on the condensed consolidated financial statements as a result of future adoption.

2. GOING CONCERN

The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern and will continue to conduct operations for the foreseeable future and realize assets and discharge liabilities in the ordinary course of operations. As of April 30, 2020, the Company had cash and cash equivalents of $0.3 million and working capital deficit of $2.1 million. The Company has incurred recurring losses and negative cash flows from operations since inception and has funded its operating losses through the sale of common stock, preferred stock, warrants to purchase common stock and the issuance of notes. The Company incurred a net loss of $2.0 million and $3.6 million for the three months ended April 30, 2020 and 2019, respectively. The Company had an accumulated deficit of $90.2 million as of April 30, 2020.

Prior to the Merger, the Company’s limited operating history and need for significant additional financing in the future raised substantial doubt about its ability to continue as a going concern. Although the Company generated gross proceeds of $25.0 million from the private placement transaction in May 2020 as discussed in Note 1, the Company expects its expenses to increase in connection with its ongoing research and development of its pipeline of programs and additional costs as a public company. The Company anticipates incurring additional losses for the foreseeable future and may never become profitable. If the Company is unable to maintain sufficient financial resources, its business, financial condition and results of operations will be materially and adversely affected. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not contain any adjustments that might result from the resolution of any of the above uncertainties.

3. FAIR VALUE MEASUREMENTS

The Company recognizes and discloses the fair value of its assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to valuations based upon unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to valuations based upon unobservable inputs that are significant to the valuation (Level 3 measurements). Each level of input has different levels of subjectivity and difficulty involved in determining fair value.

As of January 31, 2020, the Company recorded a $0.4 million common stock liability, which was classified as Level 1 within the fair value hierarchy. There was no recorded common stock liability as of April 30, 2020.

5. COMMITMENTS AND CONTINGENCIES

Commitments

See Note 9 for discussion regarding the Company’s operating lease commitment. 

Legal Proceedings

The Company may become subject to legal proceedings, claims and litigation arising in the ordinary course of business. In addition, the Company may receive letters alleging infringement of patents or other intellectual property rights. The Company is not a party to any material legal proceeding, nor is it aware of any pending or threatened litigation that the Company believes is likely to have a material adverse effect on its business, results of operations, cash flows or financial condition should such litigation be resolved unfavorably. These claims, even if not meritorious, could result in the expenditure of significant financial resources and diversion of management efforts.

Indemnification

The Company enters into standard indemnification arrangements in the ordinary course of business. Pursuant to these arrangements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third-party with respect to the Company’s technology. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these agreements is not determinable because it involves claims that may be made against the Company in the future, but have not yet been made.

The Company has entered into indemnification agreements with its directors, officers and certain of its medical advisors that may require the Company to indemnify its directors, officers and such medical advisors against liabilities that may arise by reason of their status or service in these roles, other than liabilities arising from willful misconduct of the individual. The Company has not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. No liability associated with such indemnifications has been recorded to date.

6. STOCKHOLDERS’ DEFICIT

Common Stock

On January 28, 2020, in connection with the Bridge Loan, the Company issued a warrant to purchase Common Stock. The warrant was exercised on a cashless basis for a total amount 183,361 shares of the Company’s Common Stock. See Note 10 for discussion regarding the Bridge Loan.

The summary table above does not include warrants to purchase Common Stock issued after April 30, 2020 as described in Note 1.

Equity Incentive Plan

On July 5, 2016, the Company adopted the 2016 Equity Incentive Plan (“2016 Plan”), which permits the Company to grant equity awards to directors, officers, employees and consultants. In connection with the adoption of the 2016 Plan, the Company ceased to grant equity awards under its 2014 Equity Incentive Plan (“2014 Plan”), which was adopted on January 23, 2014. All grants and awards under the 2014 Plan, including stock options previously issued under BioPharmX, Inc.’s 2011 Equity Incentive Plan that were substituted with stock options issued under the 2014 Plan, remain in effect in accordance with their terms. Stock options generally vest in one to four years and expire ten years from the date of grant. In March 2017, the 2016 Plan was amended and the shares reserved for issuance was increased by 66,666 shares to a total of 80,000 shares. In August 2018, the 2016 Plan was amended and the shares reserved for issuance were increased by 166,666 shares to a total of 246,666 shares of common stock. The 2014 Plan and 2016 Plan are referred to collectively as the “Plans.”

The following table summarizes the Company’s stock option awards under the Plans:

Inducement Grants

The Company has also awarded inducement option grants to purchase Common Stock to new employees outside of the 2016 Plan as permitted under Section 711(a) of the NYSE American Company Guide. Such options vest at the rate of 25% of the shares on the first anniversary of the commencement of such employee’s employment with the Company, and then one forty-eighth (1/48) of the shares monthly thereafter subject to such employee’s continued service. The following table summarizes the Company’s inducement grant stock option activities:

The following table summarizes significant ranges of outstanding and exercisable options as of April 30, 2020:

There were no stock option exercised during the three months ended April 30, 2020. The total intrinsic value of stock options exercised during the three months ended April 30, 2019 was less than $1,000.

The Company estimates the fair value of stock options granted using the Black-Scholes pricing model. This model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. For employee grants, the fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. As of April 30, 2020, total compensation costs related to unvested, but not yet recognized, stock-based awards was $0.6 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted average remaining period of 2.11 years and will be adjusted for subsequent changes in estimated forfeitures.

Valuation Assumptions

There were no stock options granted during the three months ended April 30, 2020. During the three months ended April 30, 2019, the grant date fair value of stock options granted was $16.32 per share. The following assumptions were used to calculate the estimated fair value of awards granted for the periods ended:

Expected Term

The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. For awards granted subject only to service vesting requirements, the Company utilizes the simplified method for estimating the expected term of the stock-based award, instead of historical exercise data.

Expected Volatility

The Company uses the historical volatility of the price of shares of common stock of selected public companies, including the Company’s stock price, in the biotechnology sector due to its limited trading history.

Risk-Free Interest Rate

The Company bases the risk-free interest rate used in the Black-Scholes pricing model upon the implied yield curve currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the assumption in the model.

Expected Dividend

The Company has never paid dividends on its common shares and currently does not intend to do so and, accordingly, the dividend yield percentage is zero for all periods.

8. INCOME TAXES

The Company evaluates its ability to recover deferred tax assets, in full or in part, by considering all available positive and negative evidence, including past operating results and its forecast of future taxable income on a jurisdictional basis. The Company bases its estimate of current and deferred taxes on the tax laws and rates that are currently in effect in the appropriate jurisdiction. Changes in laws or rates may affect the tax provision as well as the amount of deferred tax assets or liabilities.

Current tax laws impose substantial restrictions on the utilization of net operating loss (“NOL”) and credit carryforwards in the event of an “ownership change,” as defined by the Internal Revenue Code. If there should be an ownership change, the Company’s ability to utilize its carry-forwards could be limited. Although the Company has not conducted a formal NOL carryforward analysis, as a result of the registered direct offering in March 2019, ownership change resulting from the Merger and prior financing transactions, the NOL and credit carryforwards amounts may be materially limited.

As of April 30, 2020 and January 31, 2020, the Company has not recorded any liability for unrecognized tax benefits related to uncertain tax positions. The 2010 to 2020 tax years remain open for examination by the federal and state authorities.

9. LEASES

On October 30, 2018, the Company signed a lease for 11,793 square feet of office and laboratory space in San Jose, California. The lease commenced in December 2018 and will terminate in December 2023. The lease requires payment of maintenance, utilities, taxes, insurance and other operating expenses associated with the leased space. On February 14, 2020, the Company entered into a sublease agreement for its 11,793 square feet office and laboratory space in San Jose, California. The sublease covers the term of the master lease. Payments from the sublease are expected to materially offset the costs for lease and related operating expenses. The Company paid approximately $103,000 related to the consummation of the sublease for the remainder of the master lease. The Company analyzed the operating lease right-of-use asset and determined that the $103,000 should be expensed in operations as there is no related increase to the right-of-use asset.

Lease expense is recognized on a straight-line basis over the lease term and was approximately $93,000 for each of the three months ended April 30, 2020 and 2019. Cash paid for amounts included in the measurement of the operating lease liability for the three months ended April 30, 2020 and 2019 was approximately $93,000 and $65,000, respectively, and was included in net cash used in operating activities in the statement of cash flows. The Company received approximately $94,000 in sublease income for the three months ended April 30, 2020, which was offset against rent expense within operating expenses.

The future minimum payments and future minimum income for sublease rentals under the Company’s operating lease as of April 30, 2020 are as follows (in thousands):

The Company recorded financing leases related to laboratory equipment purchased in March 2018 and May 2019. The leased asset values were approximately $61,000 and $54,000, respectively, and the corresponding current and long-term liabilities were recorded in accrued expenses and other current liabilities and other long-term liabilities, respectively. In February 2020, the Company paid approximately $70,000 to execute the buyout provisions of the financing leases.

10. NOTE PAYABLE

In connection with the Merger Agreement, the Company and Timber Sub entered into a Credit Agreement, dated as of January 28, 2020, pursuant to which Timber Sub agreed to make a Bridge Loan to the Company in an aggregate amount of $2.25 million. Pursuant to the terms of the Credit Agreement, Timber Sub made the Bridge Loan to the Company in three tranches: (i) a $625,000 initial advance ($700,000 less $75,000 of original issue discount (“OID”)) made on the closing date of the Credit Agreement; (ii) $625,000 ($700,000 less $75,000 of OID) 30 days thereafter; and (iii) $1,000,000 ($1,100,000 less $100,000 of OID) upon the closing of the Merger. The Bridge Loan bears interest at a rate of 12% per annum and is repayable on June 15, 2020, subject to extension for an additional month under certain circumstances, the termination (without completion) of the Merger or upon a liquidity event, as defined in the Credit Agreement. The Company also issued to Timber Sub a promissory note setting forth the terms of repayment (the “Note”).

The Bridge Loan is collaterized by a lien on all of the Company's assets. Further, in connection with the Bridge Loan, on January 28, 2020 the Company issued to Timber Sub a warrant to purchase approximately 187,944 shares of common stock at an exercise price of $0.12 (the “Bridge Warrant”). The Bridge Warrant was exercised on a cashless basis on February 10, 2020 for a total amount of 183,361 shares of the Company’s common stock.

As of January 31, 2020, the Company received the initial tranche of $625,000 and recorded the note payable based on the relative fair values of the Bridge Warrant and Note. To value the Bridge Warrrant, the Company used the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 1.44%, contractual term of 30 months, expected volatility of 70.3% and a dividend rate of 0%. The fair value of the Bridge Warrant was approximately $460,000 and was recorded as additional paid-in capital and a discount on the Bridge Loan. The debt discount and issuance costs of $522,000 as of January 31, 2020 will be amortized through June 15, 2020. On February 28, 2020, the Company received the second tranche payment of $625,000. The Company recorded approximately $388,000 in note discount in interest expense for the three months ended April 30, 2020.

11. SUBSEQUENT EVENTS

On May 18, 2020, the Company completed its business combination with Timber Sub, received the third tranche payment of $1.0 million under the Bridge Loan, effected a Reverse Stock Split and became obligated to issue warrants to purchase Common Stock pursuant with the Securities Purchase Agreement. See Note 1 for further discussion.