The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

NOTE 1. ORGANIZATION

NovaBay Pharmaceuticals, Inc. (the “Company”) develops and sells scientifically-created and clinically-proven eyecare, skincare and wound care products. Our leading product, Avenova® Antimicrobial Lid and Lash Solution, or Avenova Spray, is proven in laboratory testing to have broad antimicrobial properties as it removes foreign material including microorganisms and debris from the skin around the eye, including the eyelid. Avenova Spray is formulated with our proprietary, stable and pure form of hypochlorous acid and is cleared by the FDA for sale in the United States. Avenova Spray is available direct to consumers primarily through online distribution channels and is also available by prescription and dispensed by eyecare professionals for blepharitis and dry-eye disease. Other eyecare products offered under the Avenova eyecare brand include Novawipes by Avenova, Avenova Lubricant Eye Drops, Avenova Moist Heating Eye Compress, and the i-Chek eyelid and eyelash mirror by Avenova.

Through our subsidiary DERMAdoctor, LLC (“DERMAdoctor”), the Company offers over 30 dermatologist-developed products targeting common skin concerns, ranging from aging and blemishes to dry skin, perspiration and keratosis pilaris. DERMAdoctor branded products are marketed and sold through the DERMAdoctor website, well-known traditional and digital beauty retailers, and a network of international distributors. We acquired DERMAdoctor in November 2021 (the “DERMAdoctor Acquisition”), and since completing this transaction we have been working to integrate and expand the DERMAdoctor business in order to achieve strategic objectives contemplated by the acquisition, including revenue growth, cost reductions and overall profitability.

The Company also manufactures and sells its proprietary form of hypochlorous acid for the wound care market through our NeutroPhase and PhaseOne branded products. NeutroPhase and PhaseOne are used for the cleansing and irrigation as part of surgical procedures, as well as treating certain wounds, burns, ulcers and other injuries. The Company currently sells these products through distributors.

The Company was incorporated under the laws of the State of California on January 19, 2000, as NovaCal Pharmaceuticals, Inc. It had no operations until July 1, 2002, on which date it acquired all of the operating assets of NovaCal Pharmaceuticals, LLC, a California limited liability company. In February 2007, it changed its name from NovaCal Pharmaceuticals, Inc. to NovaBay Pharmaceuticals, Inc. In June 2010, the Company changed the state in which it was incorporated (the “Reincorporation”) and is now incorporated under the laws of the State of Delaware. All references to “the Company” herein refer to the California corporation prior to the date of the Reincorporation and to the Delaware corporation on and after the date of the Reincorporation. The Company is managed as two reportable segments: (1) Eyecare and Wound Care and (2) Skincare.

Effective November 15, 2022, the Company effected a 1-for-35 reverse split of our outstanding common stock (“Reverse Stock Split”) (See Note 12, “Stockholders’ Equity” for further details). Except as otherwise specifically noted, all share numbers, share prices, exercise/conversion prices and per share amounts have been adjusted, on a retroactive basis, to reflect this 1-for-35 reverse stock split.

Liquidity and Going Concern

Based primarily on the funds available on March 31, 2023 and the 2023 Private Placement (as defined elsewhere in this Quarterly Report) completed subsequent to March 31, 2023 as further described in Note 18, “Subsequent Events”, the Company believes that the Company’s existing cash and cash equivalents and cash flows generated from product sales will be sufficient to fund its existing operations and meet its planned operating expenses into at least the second quarter of 2024. The Company has sustained operating losses for the majority of its corporate history and expects that its 2023 expenses will exceed its 2023 revenues, as the Company continues to invest in both its Avenova and DERMAdoctor commercialization efforts. Additionally, the Company expects to continue incurring operating losses and negative cash flows until revenues reach a level sufficient to support ongoing growth and operations. Accordingly, the Company has determined that its planned operations raise substantial doubt about its ability to continue as a going concern. Additionally, changing circumstances may cause the Company to expend cash significantly faster than currently anticipated, and the Company may need to spend more cash than currently expected because of circumstances beyond its control that impact the broader economy such as periods of inflation, supply chain issues, the continuation of the COVID-19 pandemic and international conflicts (e.g., the conflict between Russia and Ukraine).

The Company’s long-term liquidity needs will be largely determined by the success of commercialization efforts. To address the Company’s current liquidity and capital needs, the Company has and continues to evaluate different plans and strategic transactions to fund operations, including: (1) raising additional capital through debt and equity financings or from other sources; (2) reducing spending on operations, including reducing spending on one or more of its sales and marketing programs or restructuring operations to change its overhead structure; (3) out-licensing rights to certain of its products or product candidates, pursuant to which the Company would receive cash milestones or an upfront fee; and/or (4) entering into license agreements to sell new products. The Company may issue securities, including common stock, preferred stock, convertible debt securities and warrants through additional private placement transactions or registered public offerings, which may require the filing of a Form S-1 or Form S-3 registration statement with the Securities and Exchange Commission (“SEC”). The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. These unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from uncertainty related to its ability to continue as a going concern. 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and are expressed in U.S. dollars. In management’s opinion, the unaudited condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of the Company’s financial position and operating results.

Use of Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. These estimates include contract liabilities related to product sales such as product returns, assumptions for valuing warrants, the fair value of contingent consideration, intangible assets, goodwill, stock-based compensation, income taxes and other contingencies.

These estimates are based on management’s best estimates and judgment. Actual results may differ from these estimates. Estimates, judgments, and assumptions are continuously evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Uncertainty about these assumptions, judgments and estimates could result in outcomes that require a material adjustment to the carrying amount of assets or liabilities affected in future periods.

Unaudited Condensed Consolidated Interim Financial Information

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

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

The condensed consolidated financial statements and notes included herein should be read in conjunction with the annual consolidated financial statements and notes for the year ended December 31, 2022, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, which was filed with the SEC on March 31, 2023.

Change in Accounting and Revision of Prior Period Financial Statements

During the third quarter of 2022, the Company made an accounting policy change election related to fulfillment fees paid to third-party online retailers such as Amazon. The Company began expensing these fees as incurred as product cost of goods sold in the Company’s condensed consolidated statements of operations. The Company previously recorded revenue net of these fees. The Company believes that making this change is appropriate and preferable as it is more consistent with the practices of comparable companies as the Company increasingly focuses on commercial growth in our direct to consumer on-line channels. Changes to prior period amounts presented in this report have been made to conform to the current period presentation. See additional information under “Revenue Recognition” below. The changes had no impact on operating loss, net loss or net loss per share in the Company’s unaudited condensed consolidated statements of operations in the periods presented in this report or in previously issued annual and quarterly financial statements. The changes also did not impact cash or ending cash balances in the Company’s unaudited condensed consolidated balance sheets in the periods presented in this report or in previously issued annual and quarterly financial statements.

While reviewing its accounting policy for fulfillment fees during the third quarter of 2022, the Company identified an error in its previously issued financial statements whereby the Company had been incorrectly presenting revenue net of selling commissions paid to third-party online retailers. During the third quarter of 2022, the Company concluded that these commissions relate to sales activity and began expensing them as incurred as sales and marketing expenses within the Company’s unaudited condensed consolidated statements of operations. The identified error impacted the Company’s previously issued 2022 first and second quarter condensed consolidated financial statements, as well as the 2021 annual consolidated financial statements. Management believes that the impact of these adjustments to correct such error is immaterial to the previously issued consolidated financial statements, based on an evaluation of both quantitative and qualitative factors. However, revisions to prior period amounts presented in this report have been made to conform to the current period presentation. See additional information under “Revenue Recognition” below. The revisions had no impact on operating loss, net loss or net loss per share in the Company’s unaudited condensed consolidated statements of operations in the periods presented in this report or in previously issued annual consolidated financial statements. The changes also did not impact cash or ending cash balances in the Company’s condensed consolidated balance sheets in the periods presented in this report or in previously issued annual consolidated financial statements.

Cash, Cash Equivalents, and Restricted Cash

The Company considers all highly-liquid instruments with a stated maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates fair value. As of March 31, 2023 and December 31, 2022, the Company’s cash and cash equivalents were held in a major financial institution in the United States.

The following table provides a reconciliation of the cash, cash equivalents, and restricted cash reported in the condensed consolidated balance sheets (in thousands):

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

Concentrations of Credit Risk and Major Partners

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

The Company has a significant amount of its cash balances at financial institutions which throughout the year regularly exceed the federally insured limit of $250,000. Any loss incurred or a lack of access to such funds could have a significant adverse impact on the Company’s financial condition, results of operations, and cash flows.

During the three months ended March 31, 2023 and 2022, revenues were derived primarily from sales of Avenova and DERMAdoctor branded products, directly to consumers through Amazon.com, Avenova.com and DERMAdoctor.com.

During the three months ended March 31, 2023 and 2022, revenues from significant product categories were as follows (in thousands):

During the three months ended March 31, 2023 and 2022, sales of Avenova Spray via Amazon comprised 75% and 82% of total Avenova Spray net revenue, respectively. No other individual distributor comprised greater than 10% of total Avenova Spray net revenue during the three months ended March 31, 2023 or 2022.

As of March 31, 2023 and December 31, 2022, accounts receivable from our major distribution partners and major retailers greater than 10% were as follows:

* Less than 10%

The Company relies on seven contract manufacturers to produce its products. The Company does not own any manufacturing facilities and intends to continue to rely on third parties for the supply of finished goods. Contract manufacturers may or may not be able to meet the Company’s needs with respect to timing, quantity or quality. In particular, it is possible that the Company may suffer from unexpected delays in light of the global supply chain issues.

Fair Value of Financial Assets and Liabilities

The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities, warrant liabilities, and contingent consideration. The Company’s cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities are carried at cost, which management believes approximates fair value due to the short-term nature of these instruments.

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

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

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

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

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

Allowance for Credit Losses

The Company maintains an allowance for estimated losses resulting from the inability of its customers to meet their financial obligations to the Company. The Company recognizes an allowance for credit losses based on factors such as historical experience, contract terms and general and market business conditions. The Company’s future collection experience can differ significantly from historical collection trends due to such factors as changing customer circumstances and uncertain economic and industry trends. Management recorded a reserve for allowance for credit losses of $3 thousand and $19 thousand as of March 31, 2023 and December 31, 2022, respectively.

Inventory

Inventory is comprised of (1) raw materials and supplies, such as bottles, packaging materials, labels, boxes and pumps; (2) goods in progress, which are normally filled but unlabeled bottles; and (3) finished goods. The Company utilizes contract manufacturers to produce our products and the price paid to these manufacturers is included in inventory. Inventory is stated at the lower of cost or estimated net realizable value determined by the first-in, first-out method. At March 31, 2023 and December 31, 2022, management had recorded an allowance for excess and obsolete inventory at the lower of cost or estimated net realizable value of $488 thousand and $499 thousand, respectively.

Property and Equipment, net

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

The costs of normal maintenance, repairs, and minor replacements are expensed as incurred.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill represents the excess of the consideration transferred over the estimated fair value of assets acquired and liabilities assumed in a business combination. Intangible assets are measured at their respective fair values as of the acquisition date and may be subject to adjustment within the measurement period, which may be up to one year from the acquisition date. Goodwill and indefinite-lived intangible assets are tested for impairment annually, or more frequently if events or changes in circumstances indicate that it is more likely than not that the assets are impaired.

The Company did not record any goodwill or indefinite-lived asset impairment charges during the three months ended March 31, 2023 or 2022.

Valuation of Contingent Consideration Resulting from a Business Combination

In connection with certain acquisitions, including the DERMAdoctor Acquisition, the Company may be required to pay future consideration that is contingent upon the achievement of specified milestone events. The Company records contingent consideration resulting from a business combination at its fair value on the acquisition date. Each quarter thereafter, the Company revalues these obligations and records increases or decreases in the fair value within the consolidated statement of operations until such time as the specified milestone achievement period is complete.

Increases or decreases in fair value of the contingent consideration liabilities can result from updates to assumptions such as the expected timing or probability of achieving the specified milestones. Significant judgment is employed in determining these assumptions as of the acquisition date and for each subsequent period. Updates to assumptions could have a significant impact on the Company’s results of operations in any given period. Actual results may differ from estimates.

DERMAdoctor Acquisition milestone events consist of financial targets for calendar years 2022 and 2023. The financial target was not met for the calendar year 2022. Additionally, we do not expect the financial target to be met for the calendar year 2023. As a result, the liability recorded for potential earn out payments in the Company’s condensed consolidated balance sheets was zero as of March 31, 2023 and December 31, 2022. This amount is subject to change in the event that there are changes to our expectations and related valuation assumptions.

Long-Lived Assets 

The Company’s intangible assets that do not have indefinite lives (primarily trade secrets / product formulations) are amortized over their estimated useful lives. All of the Company’s intangible assets subject to amortization and other long-lived assets, are reviewed for impairment in accordance with ASC 360, Property, Plant and Equipment, which requires that companies consider whether events or changes in facts and circumstances, both internally and externally, may indicate that an impairment of long-lived assets held for use are present. The Company reviews long-lived assets for impairment at least annually or whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the assets are written down to their estimated fair values and the loss is recognized in the consolidated statements of operations.

The Company did not record any long-lived asset impairments during the three months ended March 31, 2023 or 2022.

Leases

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

The Company has elected to combine lease and non-lease components as a single component for all leases in which it is a lessee or a lessor. The lease expense is recognized over the expected term on a straight-line basis. Operating leases are recognized on the consolidated balance sheet as right-of-use assets, operating lease liabilities current and operating lease liabilities non-current.

Revenue Recognition

Revenue is recognized from the sale of goods in accordance with ASC 606, Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue when or as the Company’s performance obligations are satisfied by transferring control of the promised goods to customers in an amount that reflects the consideration to which the Company expects to receive. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the Company performs the following five steps as prescribed by ASC 606:

Revenue is generated through the Company’s webstores, Avenova.com and DERMAdoctor.com, for Avenova and DERMAdoctor products. Such direct to consumer sales are recognized upon fulfillment, which generally occurs upon delivery of the related products to a third-party carrier. Shipping and handling costs are expensed as incurred and included in product cost of goods sold in the consolidated statements of operations. The Company presents revenue net of sales taxes and refunds. 

Revenue generated through third-party online retailers, including Amazon, is recognized when control of the goods is transferred to the customer, which generally occurs upon delivery of the products to a third-party carrier.

The Company pays third-party online retailers advertising & promotion fees, selling commissions and fulfillment fees. Advertising & promotion fees are expensed as incurred as sales and marketing expenses within operating expenses in the consolidated statements of operations. Prior to the third quarter of 2022, the Company recorded revenue net of selling commissions and fulfillment fees. Beginning in the third quarter of 2022, as further described below, the Company began expensing selling commissions as sales and marketing expenses in the consolidated statements of operations and fulfillment fees as product cost of goods sold in the consolidated statements of operations.

Prior to the third quarter of 2022, to determine its accounting for fulfillment fees, the Company evaluated principal versus agent considerations with respect to the obligation to ship its product to the customer. The Company assessed whether the nature of the Company’s obligation is as a principal in providing the fulfillment service or as an agent in promising to arrange for a third party to provide the fulfillment service. The Company concluded that it is an agent with respect to the shipping service as the Company does not control the service itself and, therefore, its obligation is that of a promise to arrange for the service. This determination involved significant judgement. In accordance with this conclusion, prior to the third quarter of 2022, the Company recorded revenue net of fulfillment fees. Beginning in the third quarter of 2022, the Company made an accounting policy change election, as a practical expedient, to account for the shipping fees as a fulfillment activity and began expensing them as incurred within product cost of goods sold in the Company’s consolidated statements of operations. Management believes the resulting accounting changes are preferable as they conform the Company’s practice to a majority of comparable filers and other similar sales channels. Changes to amounts presented for prior periods have been made to conform to these changes. These changes did not impact operating loss, net loss or loss per share in the Company’s condensed consolidated statements of operations in the periods presented in this report or in previously issued annual consolidated financial statements. The changes also did not impact cash or ending cash balances in the Company’s condensed consolidated balance sheets in the periods presented in this report or in previously issued annual consolidated financial statements.

Prior to the third quarter of 2022, the Company also recorded revenue net of selling commissions. During the third quarter of 2022, the Company concluded that these commissions relate to a sales activity and began expensing them as incurred as sales and marketing expenses within the Company’s consolidated statements of operations. The Company determined that its treatment prior to the third quarter of 2022 was an error. The identified error impacted the Company's previously issued 2022 and 2021 quarterly, and 2021 and 2020 annual consolidated financial statements. Management believes that the impact of this error is immaterial to the previously issued consolidated financial statements, based on an evaluation of both quantitative and qualitative factors. However, revisions to prior period amounts presented in this report have been made to conform to the current period presentation as outlined below. The revisions had no impact on operating loss, net loss or net loss per share in the Company’s condensed consolidated statements of operations in the periods presented in this report or in previously issued annual consolidated financial statements. The changes also did not impact cash or ending cash balances in the Company’s condensed consolidated balance sheets in the periods presented in this report or in previously issued annual consolidated financial statements.

Financial statement line items included in the condensed consolidated statements of operations for the three months ended March 31, 2022 were adjusted for the above changes as follows (in thousands, except per share amounts):

The Company also generates Avenova Spray revenue through major pharmacy distribution partners. Product supply of Avenova Spray is the only performance obligation contained in these arrangements, and the Company recognizes product revenue upon transfer of control to its major distribution partners at the amount of consideration that the Company expects to be entitled to, generally upon delivery to the distributor on a “sell-in” basis. Upon recognition of product sales, contract liabilities are recorded for invoiced amounts that are subject to reversal, including product revenue allowances for cash consideration paid to customers for services, discounts, rebate programs, and product returns. The Company derives its rate of return and other contract liabilities from historical data and updates its assumptions quarterly. Payment for product supply is typically due 30 days after control transfers to the distributor.

Revenue for products sales to Costco is recognized upon transfer of control at the amount of consideration that the Company expects to be entitled to, generally upon delivery to Costco. Upon recognition of product sales, contract liabilities are recorded for invoiced amounts that are subject to reversal, including discounts and product returns. The Company derives its rate of return from historical data and updates its return rate assumption quarterly. Payment for product supply is typically due 30 days after control transfers to Costco.

Revenue generated through the Company’s partner pharmacies is recognized when control of the product transfers to the end customer.

Revenue for product sales to other retailers, such as CVS, is generally recognized upon transfer of control to the retailer, which generally occurs upon delivery of the products to a third-party carrier, net of estimated future product returns.

The Company may be required to defer recognition of revenue for upfront payments until it performs its obligations under these arrangements, and such amounts are recorded as deferred revenue upon receipt. Deferred revenue was $307 thousand and $4 thousand as of March 31, 2023 and December 31, 2022, respectively.

Cost of Goods Sold

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

Research and Development Costs

The Company charges research and development costs to expense as incurred. These costs include all costs associated with research, development and regulatory activities, including submissions to the Food and Drug Administration (the “FDA”).

Patent Costs

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

Advertising Costs

Advertising costs are expensed in the period in which the costs are incurred. Advertising costs are included in sales and marketing expenses in the condensed consolidated statements of operations. Advertising expenses were $326 thousand and $617 thousand for the three months ended March 31, 2023 and 2022, respectively.

Stock-Based Compensation

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

Income Taxes

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

Common Stock Warrants

The Company accounts for common stock purchase warrants issued in connection with its equity offerings in accordance with the provisions of ASC 480, Distinguishing Liabilities from Equity, and ASC 815, Derivatives and Hedging.

The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and if that event is outside the control of the Company), (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement) or (iii) do not become exercisable until the occurrence of a contingent event.

For warrants that are classified as liabilities, the Company records the fair value of the warrants at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the condensed consolidated statements of operations. The fair values of these warrants are determined using the Black-Scholes option pricing model, the Binomial Lattice (“Lattice”) valuation model, or the Monte Carlo simulation model where deemed appropriate. These values are subject to a significant degree of management’s judgment.

Net Loss per Share

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

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

The following table sets forth the calculation of basic EPS and diluted EPS (in thousands, except per share amounts):

For the three months ended March 31, 2023 and 2022, Series B Non-Voting Convertible Preferred Stock (the “Series B Preferred Stock”) and the Series C Non-Voting Convertible Preferred Stock (the “Series C Preferred Stock”) were excluded from the computation of diluted net loss per share as their inclusion on an “if converted” basis would have been anti-dilutive. The Series B Preferred Stock and Series C Preferred Stock were considered anti-dilutive because such securities did not have a contractual obligation to participate in losses of the Company.

The following outstanding stock options and stock warrants were excluded from the diluted EPS computation as their effect would have been anti-dilutive (in thousands):

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements that could affect our business, results of operations, financial condition, and liquidity, see Note 2, “Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2022, which was filed with the SEC on March 31, 2023. The Company continues to evaluate the potential impact of adopting the new accounting guidance on its consolidated financial position, results of operations and cash flows.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. ASU 2016-13 is effective for the Company for annual and interim reporting periods beginning January 1, 2023. The Company adopted the new standard effective January 1, 2023, and the adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

NOTE 3. FAIR VALUE MEASUREMENTS 

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

The following table presents the Company’s cash equivalent assets measured at fair value on a recurring basis as of March 31, 2023 (in thousands):

The following table presents the Company’s cash equivalent assets measured at fair value on a recurring basis as of December 31, 2022 (in thousands):

Depreciation expense was $13 thousand and $30 thousand for the three months ended March 31, 2023 and 2022, respectively.

In the fourth quarter of 2022, the Company determined that certain of its indefinite-lived and long-lived amortizable intangible assets related to its DERMAdoctor business were impaired. As such, the Company recorded an intangible asset impairment charge of $2.6 million in the fourth quarter of 2022, which was reflected in the “Goodwill, Intangible and Other Asset Impairment” caption in the Company’s consolidated statements of operations. The Company did not record any intangible asset impairment charges for the three months ended March 31, 2023 or 2022.

Amortization expense was $38 thousand and $91 thousand for the three months ended March 31, 2023 and 2022, respectively. Based on the amortizable intangible assets as of March 31, 2023, future amortization expenses are expected to be as follows (in thousands):

NOTE 9. LINE OF CREDIT

At the time of the DERMAdoctor Acquisition, DERMAdoctor had a line of credit agreement with Bank Midwest for $500 thousand. As of March 31, 2023 and December 31, 2022, there was no outstanding balance on the line of credit as such line of credit was terminated and repaid in full during the quarter ended March 31, 2022.

NOTE 10. COMMITMENTS AND CONTINGENCIES

Indemnification Agreements

As permitted under Delaware law and in accordance with its bylaws, the Company indemnifies its officers and directors for certain events or occurrences while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and may enable it to recover a portion of any future payments. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, it has not recorded any liabilities for these agreements as of March 31, 2023 or December 31, 2022. 

In the normal course of business, the Company provides indemnification of varying scope under its agreements with other entities, typically its clinical research organizations, investigators, clinical sites, suppliers, and others. Pursuant to these agreements, it generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified parties in connection with the use or testing of its products or product candidates or with any U.S. patent or any copyright or other intellectual property infringement claims by any third party with respect to its products. The term of these indemnification agreements is generally perpetual. The potential future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, costs related to these indemnification provisions have been immaterial. The Company also maintains various liability insurance policies that limit its exposure. As a result, it believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of March 31, 2023 or December 31, 2022. 

Legal Matters

As of March 31, 2023 and December 31, 2022, there were no legal matters that, in the opinion of management, would ultimately result in liability that would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Leases

The Company leases office space for its corporate headquarters located in Emeryville, California. The initial lease term was scheduled to expire on February 28, 2022, but on January 19, 2022, the Company exercised its option to extend the term and amended the lease to extend the term through July 31, 2027.

The Company is also party to a lease for 19,136 square feet of space located in Riverside, Missouri, which it utilizes for light manufacturing, storage, distribution of products and administrative functions. The lease commenced on October 1, 2019 and expires on December 31, 2024.

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

The components of lease expense for the three months ended March 31, 2023 and 2022 were as follows (in thousands):

The Company has measured its operating lease liabilities at its incremental borrowing rate over the remaining term for each operating lease. The weighted average remaining lease term and the weighted average discount rate are summarized as follows:

Future lease payments under non-cancelable leases as of March 31, 2023 were as follows (in thousands):

NOTE 11. WARRANT LIABILITY

See additional discussion of the terms of the Company’s various warrants and related transactions in Note 12, “Stockholders’ Equity”. Further, many of the defined terms used below are defined in Note 12, “Stockholders’ Equity”.

September 2022 Warrants

The September 2022 Warrants were issued by the Company on September 9, 2022, in connection with the 2022 Warrant Reprice Transaction. The September 2022 Warrants were not exercisable prior to the effective date of the Reverse Stock Split, which was approved by Company stockholders on November 10, 2022. Under ASC 480, Distinguishing Liabilities from Equity, the September 2022 Warrants were classified as liabilities from the date of issuance through the date of approval of the Reverse Stock Split at which time they were reclassified to equity.

The fair value of the September 2022 Warrants was determined to be $1.4 million as of the date of issuance on September 9, 2022 in accordance with the following key assumptions, which was recorded as a liability:

The fair value of the September 2022 Warrants was determined to be $0.5 million as of the date of approval by Company stockholders on November 10, 2022 in accordance with the following key assumptions, at which time the liability was adjusted and reclassified to equity:

November 2021 Warrants

The November 2021 Warrants were issued by the Company on November 2, 2021, in connection with the 2021 Private Placement. The November 2021 Warrants were subsequently amended in September 2022 pursuant to the 2022 Warrant Reprice Transaction.

The November 2021 Warrants were not initially exercisable prior to shareholder approval for an increase in authorized share capital which the Company received on January 31, 2022. Under ASC 480, Distinguishing Liabilities from Equity, the November 2021 Warrants were classified as liabilities from the date of issuance through the date of approval at which time they were reclassified to equity.

As of December 31, 2021 the fair value of the November 2021 Warrants was determined to be $9.6 million in accordance with the following key assumptions, which was recorded as a liability:

As of January 31, 2022, the fair value of the November 2021 Warrants was determined to be $7.5 million in accordance with the following key assumptions, at which time the liability was adjusted and reclassified to equity:

Unexercised November 2021 Warrants exercisable for 803,574 shares of common stock were amended on September 9, 2022, in connection with the 2022 Warrant Reprice Transaction. As a result of the amendment, these November 2021 Warrants were no longer exercisable prior to the effective date of the Reverse Stock Split, which was approved by Company stockholders on November 10, 2022. Under ASC 480, Distinguishing Liabilities from Equity, the November 2021 Warrants were reclassified as liabilities on the date of amendment and remained recorded as liabilities through the date of approval of the Reverse Stock Split at which time they were reclassified to equity.

The fair value of these November 2021 Warrants was determined to be $3.5 million as of the date of amendment on September 9, 2022 in accordance with the following key assumptions, at which time they were reclassified as liabilities:

As of November 10, 2022, the fair value of these November 2021 Warrants, as amended, was determined to be $1.3 million in accordance with the following key assumptions, at which time they were reclassified to equity:

Amended July 2020 Warrants

On September 9, 2022, in connection with the 2022 Warrant Reprice Transaction, the Company amended certain July 2020 Warrants. Amended July 2020 Warrants exercisable for 77,145 shares of common stock were no longer exercisable prior to the effective date of the Reverse Stock Split, which was approved by Company stockholders on November 10, 2022. Under ASC 480, Distinguishing Liabilities from Equity, these Amended July 2020 Warrants were reclassified as liabilities on the date of amendment and remained recorded as liabilities through the date of approval of the Reverse Stock Split at which time they were reclassified to equity.

The fair value of these Amended July 2020 Warrants was determined to be $0.3 million as of the date of amendment on September 9, 2022 in accordance with the following key assumptions, at which time they were reclassified as liabilities:

As of November 10, 2022, the fair value of these Amended July 2020 Warrants was determined to be $0.1 million in accordance with the following key assumptions, at which time they were reclassified to equity:

NOTE 12. STOCKHOLDERS' EQUITY

Common Stock and Preferred Stock

Under the Company’s Amended and Restated Certificate of Incorporation, as amended, the Company is authorized to issue up to 150,000,000 shares of common stock and up to 5,000,000 shares of preferred stock (with rights and preferences as may be approved by the Company’s Board of Directors).

Reverse Stock Split

Effective November 15, 2022, the Company amended its Certificate of Incorporation to effect a 1-for-35 reverse split of its outstanding common stock. The Reverse Stock Split was approved by the Company’s stockholders on November 10, 2022. As a result of the Reverse Stock Split, every 35 shares of the Company’s pre-reverse split outstanding common stock were combined and reclassified into 1 share of common stock. Proportionate voting rights and other rights of common stockholders were not affected by the reverse stock split. Any fractional shares of common stock resulting from the Reverse Stock Split were rounded up to the nearest whole share. All stock options outstanding, common stock reserved for issuance under the Company’s equity incentive plans, common stock reserved for issuance under the Series B Preferred Stock and outstanding warrants were adjusted by dividing the number of affected shares of common stock by 35 and, as applicable, multiplying the exercise/conversion price by 35. Except as otherwise specifically noted, all share numbers, share prices, exercise prices and per share amounts have been adjusted, on a retroactive basis, to reflect this 1-for-35 reverse stock split.

2022 Warrant Reprice Transaction, Amended November 2021 Warrants, Amended July 2020 Warrants and September 2022 Warrants

On September 9, 2022, the Company entered into the 2022 Warrant Reprice Transaction, which included warrant reprice letter agreements with each of the holders of the November 2021 Warrants and certain holders of the July 2020 Warrants. Pursuant to the terms of the letter agreements, the November 2021 Warrants and certain July 2020 Warrants were amended to: (i) reduce the exercise price; (ii) provide that such warrants would not be exercisable until a later date, which was March 9, 2023; and (iii) in the case of the November 2021 Warrants, extend the termination date to September 11, 2028 (as amended, the “Amended November 2021 Warrants” and the “Amended July 2020 Warrants”, respectively). The Amended November 2021 Warrants are exercisable for an aggregate of 803,574 shares of common stock at an exercise price of $6.30 per share and expire on September 11, 2028. The Amended July 2020 Warrants are exercisable for an aggregate of 77,145 shares of common stock at an exercise price of $6.30 per share and expire on January 22, 2026.

As a result of these amendments to the Amended November 2021 Warrants and the Amended July 2020 Warrants, the Company recorded a non-cash loss on modification of common stock warrants in the amount of $1.9 million. The loss represents the increase in fair value of the Amended November 2021 Warrants and the Amended July 2020 Warrants as a result of the modification. The increase in fair value was calculated as the difference in value immediately before and after modification using the Black-Scholes option pricing model. The fair value of the Amended November 2021 Warrants and the Amended July 2020 Warrants was determined to be $3.3 million immediately prior to the modification in accordance with the following key assumptions:

The fair value of the Amended November 2021 Warrants and the Amended July 2020 Warrants was determined to be $5.2 million immediately after the modification in accordance with the following key assumptions:

Additionally, in connection with the 2022 Warrant Reprice Transaction, the Company issued to certain participants in the 2022 Warrant Reprice Transaction that exercised their Amended November 2021 Warrants and their Amended July 2020 Warrants, new common stock purchase warrants (the “September 2022 Warrants”) to purchase a number of shares of common stock equal to 100% of the number of shares that a participant exercised under its November 2021 Warrant or Amended July 2020 Warrant, as applicable. The September 2022 Warrants are exercisable for an aggregate of 327,860 shares of common stock at an exercise price of $6.30 per share and expire on September 11, 2028.

The 2022 Warrant Reprice Transaction resulted in gross proceeds of approximately $2.1 million. The Company allocated the gross proceeds between the common stock issued for the Amended November 2021 Warrants and the Amended July 2020 Warrants exercised, and the September 2022 Warrants issued to participants by applying the relative fair value allocation methodology. The Company allocated $0.7 million in gross proceeds to the common stock issued for the Amended November 2021 Warrants and the Amended July 2020 Warrants exercised, and $1.4 million to the September 2022 Warrants which were classified as a liability. For additional information regarding the warrant liability and valuation, please see Note 11, “Warrant Liability”.

Ladenburg Thalmann & Co. Inc. (“Ladenburg”) served as the Company’s warrant solicitation agent for the 2022 Warrant Reprice Transaction in exchange for a fee equal to 8% of the total gross proceeds. The Company incurred total issuance costs of $529 thousand in conjunction with the 2022 Warrant Reprice Transaction. The Company allocated $166 thousand of the issuance costs to the warrant liability which was expensed in the Company’s condensed consolidated statements of operations during the third quarter of 2022. The remaining $363 thousand was recorded as a reduction of common stock and additional paid in capital in the Company’s condensed consolidated balance sheets.

Series C Preferred Stock, Short-Term Warrants and Long-Term Warrants

Concurrent with the 2022 Warrant Reprice Transaction on September 9, 2022, the Company entered into a private placement transaction with accredited investors (the “2022 Private Placement”), a private placement transaction with certain accredited investors to sell units that consisted of: (1) 3,250 shares of  Series C Preferred Stock convertible into an aggregate of 516,750 shares of common stock, (2) series A-2 warrants to purchase common stock, which are exercisable for 515,876 shares of common stock at an exercise price of $6.30 per share through May 20, 2024 (the “Short-Term Warrants”), and (3) series A-1 warrants to purchase common stock, which are exercisable for 515,876 shares of common stock at an exercise price of $6.30 per share through November 20, 2028 (the “Long-Term Warrants” and, together with the Short-Term Warrants, the “2022 Warrants”). The closing of the 2022 Private Placement was subject to receiving certain stockholder approvals (as obtained on November 10, 2022), effecting the Reverse Stock Split, as well as the satisfaction of other customary closing conditions. On November 18, 2022, the Company closed the 2022 Private Placement and received gross proceeds of $3.2 million from the sale of the Series C Preferred Stock and the 2022 Warrants.

The Series C Preferred Stock does not have any preemptive rights or a preference upon any liquidation, dissolution or winding-up of NovaBay. The Series C Preferred Stock does, however, have anti-dilution protection in the event that the Company sells or grants any of its common stock or any other securities, subject to certain limited exceptions, that would entitle the holder thereof to acquire common stock at an effective price per share that is lower than the then applicable conversion price of the Series C Preferred Stock.

Series B Preferred Stock and November 2021 Warrants

On October 29, 2021, the Company entered into the 2021 Private Placement, including a securities purchase agreement with various institutional investors to sell in a private placement offering (i) an aggregate of 15,000 shares of our newly-created Series B Preferred Stock convertible into an aggregate of 1,071,429 shares of common stock, and (ii) the November 2021 Warrants exercisable for 1,071,429 shares of common stock for net proceeds of $14.9 million. The 2021 Private Placement closed on November 2, 2021. The November 2021 Warrants became exercisable as of January 31, 2022, and will continue to be exercisable for a period of six (6) years from such date.

The Series B Preferred Stock does not have any preemptive rights or a preference upon any liquidation, dissolution or winding-up of NovaBay. The Series B Preferred Stock does, however, have anti-dilution protection in the event that the Company sells or grants any of its common stock or any other securities, subject to certain limited exceptions, that would entitle the holder thereof to acquire common stock at an effective price per share that is lower than the then applicable conversion price of the Series B Preferred Stock.

Each share of the Series B Preferred Stock that the Company issued in the 2021 Private Placement had a purchase price of $1,000 per share and was initially convertible at a conversion price of $0.40 into 2,500 shares of common stock, or an aggregate of 37,500,000 shares of common stock (which does not account for the Reverse Stock Split). On September 9, 2022, the 2022 Warrant Reprice Transaction provided for amendments to certain common stock purchase warrants to lower their exercise price to $0.18 per share as well as the issuance of the September 2022 Warrants also with an exercise price of $0.18 per share, which exercise price was lower than the then effective $0.40 conversion price of the Series B Preferred Stock (which does not account for the Reverse Stock Split). This triggered the Series B Preferred Stock anti-dilution feature, resulting in the automatic adjustment to the conversion price for each outstanding share of the Series B Preferred Stock to $0.18, and each outstanding share of Series B Preferred Stock became convertible into 5,556 shares of common stock (which does not account for the Reverse Stock Split). As a result of the change, the Company recorded a $5.7 million deemed Series B Preferred Stock dividend. The deemed dividend was recorded as a reduction to income available to common shareholders in the basic earnings per share (EPS) calculation in the third quarter of 2022. In accordance with ASC 820, the deemed dividend was measured as the difference between (1) the fair value of the Series B Preferred Stock immediately prior to the conversion price adjustment (but without the anti-dilution protection feature) and (2) the fair value of the Series B Preferred Stock immediately after the conversion price adjustment (but without the anti-dilution protection feature). The fair value of the Series B Preferred Stock was determined to be $6.8 million immediately prior the conversion price adjustment in accordance with the following key assumptions:

The fair value of the Series B Preferred Stock was determined to be $12.5 million immediately after the conversion price protection adjustment in accordance with the following key assumptions:

Thereafter, the Company effected the Reverse Stock Split, which resulted in an automatic adjustment to the conversion price for each outstanding share of the Series B Preferred Stock to $6.30, and each outstanding share of Series B Preferred Stock became convertible into 159 shares of common stock.

As of March 31, 2023, 3,380 shares of the Series B Preferred Stock had been converted into common stock. Each of the remaining 11,620 shares of the Series B Preferred Stock as of March 31, 2023, was currently convertible into 159 shares of common stock at a conversion price of $6.30 at such time. Each share of Series B Preferred Stock is now convertible into 770 shares of common stock at a conversion price of $1.30, as further described in Note 18. “Subsequent Events”.

On September 9, 2022, in connection with the 2022 Warrant Reprice Transaction, the November 2021 Warrants were amended to reduce the exercise price to $6.30 and extend the expiration date to September 11, 2028. Additionally, in conjunction with the 2022 Warrant Reprice Transaction, holders of the November 2021 Warrants, as amended, exercised a portion of their warrants at the reduced exercise price. As of March 31, 2023, November 2021 Warrants exercisable for 803,574 shares of common stock remain outstanding.

Common Stock

Common Stock Warrants

In addition to the Amended July 2020 Warrants, the Amended November 2021 Warrants, the September 2022 Warrants and the 2022 Warrants, the Company also has the following outstanding warrants:

2019 Ladenburg Warrants

In 2019, Ladenburg was granted warrants exercisable for 4,799 shares of common stock (the “2019 Ladenburg Warrants”). The 2019 Ladenburg Warrants bear an exercise price of $34.65 and an expiration date of August 8, 2024.

July 2020 Warrants

In 2020, certain of the Company’s accredited investors were granted warrants with an exercise price of $57.75 (the “July 2020 Warrants”). A portion of these warrants were subsequently amended as described above to become the Amended July 2020 Warrants. As of March 31, 2023, outstanding July 2020 Warrants which were not amended are exercisable for 59,960 shares of common stock. The July 2020 Warrants expire on January 22, 2026.

TLF Bio Innovation 2021 Warrants

In 2021, TLF Bio Innovation was granted warrants exercisable for 429 shares of common stock with an exercise price of $23.513 (the “TLF Warrants”). The TLF Warrants expire on January 15, 2026.

NOTE 13. EQUITY-BASED COMPENSATION

Equity Compensation Plans 

In  October 2007, the Company adopted the 2007 Omnibus Incentive Plan (the “2007 Plan”) to provide for the granting of equity awards, such as stock options, unrestricted and restricted common stock, stock units, dividend equivalent rights, and stock appreciation rights to employees, directors and outside consultants, as determined by the Board. The 2007 Plan expired on  March 15, 2017. Upon expiration, new awards cannot be issued pursuant to the 2007 Plan, but outstanding awards continue to be governed by its terms. Stock options granted under the 2007 Plan expire no later than ten years from the date of grant. All stock options outstanding under the 2007 Plan were fully vested as of  December 31, 2020.

In  March 2017, the Company adopted the 2017 Omnibus Incentive Plan (the “2017 Plan”), which was approved by stockholders on  June 2, 2017, to provide for the granting of equity awards, such as nonqualified stock options (“NQSOs”), incentive stock options (“ISOs”), restricted stock, performance shares, stock appreciation rights (“SARs”), RSUs and other share-based awards to employees, directors, and consultants, as determined by the Board.  The 2017 Plan does not affect awards previously granted under the 2007 Plan. Upon adoption, the 2017 Plan allowed for awards of up to 66,243 shares of the Company’s common stock, plus an automatic annual increase in the number of shares authorized for awards on the first day of each of the Company’s fiscal years beginning  January 1, 2018 through  January 1, 2027 equal to (i) 4% of the number of shares of common stock outstanding on the last day of the immediately preceding fiscal year or (ii) such lesser number of shares of common stock than provided for in Section 4(a)(i) of the 2017 Plan as determined by the Board. On March 31, 2023, the number of shares available for future awards under the 2017 Plan was increased by 81,417 shares. As of  March 31, 2023, there were 180,143 shares available for future awards under the 2017 Plan.

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

The aggregate intrinsic value in the table above is calculated as the difference between the exercise price of the underlying stock option awards and the closing market price of the Company’s common stock as quoted on the NYSE American as of March 31, 2023 for options that have a quoted market price in excess of the exercise price. There were no stock option awards exercised during the three months ended March 31, 2023 and 2022. The Company received no cash payments for the exercise of stock options during the three months ended March 31, 2023 and 2022.

As of March 31, 2023, total unrecognized compensation cost related to unvested stock options and restricted stock units was approximately $0.3 million. This amount is expected to be recognized as stock-based compensation expense in the Company’s unaudited condensed consolidated statements of operations over the remaining weighted average vesting period of 2.06 years.

Equity Awards to Employees and Directors

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

During the three months ended March 31, 2023 and 2022, the Company granted options to employees and directors to purchase an aggregate of 3,650 and 9,486 shares of common stock, respectively.

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

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

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

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

Dividend Yield—The Company has not made any dividend payments nor does the Company have plans to pay dividends in the foreseeable future.

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

During the three months ended March 31, 2023 and 2022, the Company did not grant restricted stock to employees.

For the three months ended March 31, 2023 and 2022, the Company recognized stock-based compensation expense of $75 thousand and $184 thousand, respectively, for stock-based awards to employees and directors.

NOTE 14. DISTRIBUTION AGREEMENTS

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

Avenova Spray Pharmacy Distribution Agreements and Specialty Pharmacies

Avenova Spray is made available in local pharmacies and major pharmacy retail chains under nationwide distribution agreements with McKesson Corporation, Cardinal Health and AmerisourceBergen. The Company has also entered into direct agreements with preferred pharmacy networks as part of our Partner Pharmacy Program. During the three months ended March 31, 2023, the Company earned $92 thousand in net sales revenue for its Avenova Spray product from these distribution and partner pharmacy agreements. The Company incurred a net sales loss of $199 thousand during the three months ended March 31, 2022 for its Avenova Spray product from these distribution and partner pharmacy agreements.

Under these product distribution arrangements, the Company had a contract liability balance of $1.5 million as of March 31, 2023 and $1.6 million as of December 31, 2022. The contract liability is included in accrued liabilities in the condensed consolidated balance sheets. The Company also recorded a prepayment of $8 thousand for rebates related to these distribution agreements as of March 31, 2023, with no such prepayment recorded as of December 31, 2022, that is recorded in the prepaid expenses and other current assets in the condensed consolidated balance sheets (see Note 4, “Prepaid Expenses and Other Current Assets”).

Over-the-Counter Sales of Avenova Spray

Avenova Spray is offered for sale direct to U.S. customers primarily on Amazon.com, the Company’s website (Avenova.com), Walmart.com, select CVS stores and online on CVS.com. During the three months ended March 31, 2023 and 2022, the revenue generated from over-the-counter Avenova Spray was $1.6 million and $1.8 million, respectively. 

DERMAdoctor Products Distribution Agreements

DERMAdoctor products are sold through distribution arrangements with third parties such as Costco and others. During the three months ended March 31, 2023 and 2022, the Company earned $0.1 million and $0.2 million, respectively, in sales revenue for its DERMAdoctor products from these distribution agreements.

Under these distribution arrangements, the Company had a contract liability balance of $0.3 million as of March 31, 2023, and $0.2 million as of December 31, 2022. The contract liability is included in accrued liabilities in the condensed consolidated balance sheets.

NOTE 15. EMPLOYEE BENEFIT PLAN

The Company has a 401(k) plan covering all eligible employees. The Company provides matching contributions equal to 100% of the first 3% of compensation deferred, plus 50% of the next 2% of compensation deferred. The Company contributed $32 thousand and $46 thousand to the plan during the three months ended March 31, 2023 and 2022, respectively.

Related party accounts receivable was zero and $0.2 million as of March 31, 2023 and December 31, 2022, respectively.

NOTE 17. SEGMENT REPORTING

The Company’s chief operating decision maker (“CODM”), who is the Company’s Chief Executive Officer, allocates resources and assesses performance based on financial information of the Company. The CODM reviews financial information presented for each reportable segment for purposes of making operating decisions and assessing financial performance.

Prior to the DERMAdoctor Acquisition in November 2021, the Company was managed as a single segment focused on commercializing Avenova Spray in the United States. After the DERMAdoctor Acquisition, the Company began managing and aggregating its operational and financial information in accordance with two reportable segments: (1) Eyecare & Wound Care and (2) Skincare. The Eyecare & Wound Care segment consists of products historically sold by NovaBay prior to the DERMAdoctor Acquisition. The Skincare segment consists of products acquired in the DERMAdoctor Acquisition and skincare products subsequently sold under the DERMAdoctor brand.

Select financial information for each segment is as follows: