CytoDyn Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Derivative Liabilities

Derivative Liabilities

9 Months Ended

Feb. 28, 2019

Note 5 – Derivative Liabilities

The investor and placement agent warrants, issued in connection with a registered direct offering in September 2016, contained a provision for net cash settlement in the event that there is a fundamental transaction (contractually defined as a merger, sale of substantially all assets, tender offer or share exchange, whereby such other Person or group acquires more than 50% of the outstanding common stock). If a fundamental transaction occurs in which the consideration issued consists principally of cash or stock in a successor entity, then the warrantholder has the option to receive cash equal to the fair value of the remaining unexercised portion of the warrant. Due to this contingent cash settlement provision, the investor and placement agent warrants require liability classification as derivatives in accordance with ASC 480 and ASC 815 and are recorded at fair value.

The following tables summarize the fair value of the warrant derivative liability and related common shares as of inception date September 15, 2016, May 31, 2018 and February 28, 2019:

	Shares Indexed		Derivative Liability
Inception date September 15, 2016		7,733,334	$	5,179,200
Balance May 31, 2018		7,733,334		1,323,732
Balance February 28, 2019		7,733,334	$	793,866

The Company recognized approximately $530,000 of non-cash gain and approximately $274,000 of non-cash loss, due to the changes in the fair value of the liability associated with such classified warrants during the nine months ended February 28, 2019 and February 28, 2018, respectively.

ASC 820 provides requirements for disclosure of liabilities that are measured at fair value on a recurring basis in periods subsequent to the initial recognition. Fair values for the warrants were determined using a Binomial Lattice (“Lattice”) valuation model.

The Company estimated the fair value of the warrant derivative liability as of inception date September 15, 2016, May 31, 2018 and February 28, 2019, using the following assumptions:

	September 15, 2016			May 31, 2018			February 28, 2019
Fair value of underlying stock	$	0.78		$	0.49		$	0.50
Risk free rate		1.20	%		2.63	%		2.51	%
Expected term (in years)		5			3.3			2.54
Stock price volatility		106	%		64	%		60	%
Expected dividend yield		—			—			—
Probability of Fundamental Transaction		50	%		50	%		50	%
Probability of holder requesting cash payment		50	%		50	%		50	%

Due to the fundamental transaction provision contained in the warrants, which could provide for early redemption of the warrants, the model also considered subjective assumptions related to the fundamental transaction provision. The fair value of the warrants will be significantly influenced by the fair value of the Company’s stock price, stock price volatility, changes in interest rates and management’s assumptions related to the fundamental transaction provisions.

As described in Note 4 above, the redemption provision embedded in the June 2018 and January 2019 Notes required bifurcation and measurement at fair value as a derivative. The fair value of the Note redemption provision derivative liabilities was calculated using a Monte Carlo Simulation which uses randomly generated stock-price paths obtained through a Geometric Brownian Motion stock price simulation. The fair value of the redemption provision will be significantly influenced by the fair value of the Company’s stock price, stock price volatility, changes in interest rates and management’s assumptions related to the redemption factor.

The Company estimated the fair value of the redemptive provision using the following assumptions on the closing date of Novembert 15, 2015, January 30, 2019 and February 28, 2019:

	November 15,			November 30,			January 30,			February 28, 2019
	2018			2018			2019			June Note			January Note
Fair value of underlying stock	$	0.57		$	0.58		$	0.49		$	0.50		$	0.50
Risk free rate		2.78	%		2.78	%		2.52	%		2.54	%		2.52	%
Expected term (in years)		1.61			1.61			2			1.33			1.92
Stock price volatility		58.8	%		58.8	%		61	%		61	%		61.3	%
Expected dividend yield		—			—			—			—			—
Discount factor		85	%		85	%		85	%		85	%		85	%

The following table summarizes the fair value of the convertible note redemption provision derivative liability as of inception dates November 15, 2018, January 30, 2019 and February 28, 2019:


			Derivative Liability
	Net Proceeds		Inception Date		February 28, 2019
Inception date June 2018 Note, November 15, 2018	$	5,000,000	$	1,284,988	$	1,065,646
Inception date January 2019 Note, January 30, 2019		5,000,000		1,465,008		1,332,731
					$	2,398,377

The Company recognized approximately $352,000 of non-cash gain, due to the changes in the fair value of the liability associated with such classified redemption provision between the inception date and February 28, 2019.