Quarterly report pursuant to Section 13 or 15(d)

Derivative Liability

v3.7.0.1
Derivative Liability
 9 Months Ended
Feb. 28, 2017
Derivative Liability

Note 5 – Derivative Liability:

The investor warrants issued with the September 2016 registered direct equity offering, and the placement agent warrants issued in conjunction with the offering, as fully described in Note 11, contain 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). 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), November 30, 2016 and February 28, 2017:

 

     September 15, 2016      November 30, 2016      February 28, 2017  

Total warrant derivative liability

    $ 5,179,200      $ 3,955,734      $ 3,982,400  
  

 

 

     

 

 

     

 

 

  

Shares indexed to derivative liability

      7,733,334        7,733,334        7,733,334  
  

 

 

     

 

 

     

 

 

  

Changes in the fair value of the derivative liability, carried at fair value, are reported as “Change in fair value of derivative liability” in the Consolidated Statements of Operations. During the nine months ended February 28, 2017, the Company recognized a net, non-cash gain of $1,196,800, due to changes in the fair value of the liability associated with such classified warrants and non-cash interest expense of approximately $540,000.

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, November 30, 2016 and February 28, 2017, using the following assumptions:

 

     September 15,
2016		     November 30,
2016		     February 28,
2017		  

Fair value of underlying stock

    $ 0.78     $ 0.67     $ 0.71  

Risk free rate

      1.20 %      1.81 %      1.85 % 

Expected term (in years)

      5       4.79       4.54  

Stock price volatility

      106 %      103 %      101 % 

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, 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 and management’s assumptions related to the fundamental transaction provision.

AVCP Notes

The following tables summarize the fair value of the derivative liability and linked common shares of the AVCP Notes, as of the derivative liability inception dates (September 26, 2014 and February 6, 2015) and fiscal year end May 31, 2015:

 

     September 26,
2014		      February 6,
2015		      May 31,
2015		  

Total AVCP Notes derivative liability

    $ 767,038      $ 403,266      $ 2,008,907  
  

 

 

     

 

 

     

 

 

  

Shares indexed to derivative liability

      2,000,000        1,500,000        5,185,185  
  

 

 

     

 

 

     

 

 

  

Changes in the fair value of the derivative liability, carried at fair value, are reported as “Change in fair value of derivative liability” in the Consolidated Statements of Operations. During the three and nine months ended February 28, 2017 and February 29, 2016 the Company recognized a non-cash gain of approximately $-0- and $647,000 respectively, due to the change in derivative liability related to the embedded derivative in the AVCP Notes.

ASC 815 does not permit an issuer to account separately for individual derivative terms and features embedded in hybrid financial instruments that require bifurcation and liability classification as derivative financial instruments. Rather, such terms and features must be combined together and fair valued as a single, compound embedded derivative. The Company selected a Binomial Lattice Model to value the compound embedded derivative because it believes this technique is reflective of all significant assumptions that market participants would likely consider in negotiating the transfer of this convertible note. Such assumptions include, among other inputs, stock price volatility, risk-free rates, credit risk assumptions, early redemption and conversion assumptions, and the potential for future adjustment of the conversion price due to a future dilutive financing.

Significant inputs and assumptions used in the Binomial Lattice Model for the derivative liability were as follows:

 

     September 26,
2014		     February 6,
2015		     May 31,
2015		   June 23,
2015		  

Quoted market price on valuation date

    $ 0.79     $ 0.96     $0.99   $ 0.90  

Contractual conversion rate

    $ 1.00     $ 1.00     $1.00   $ 1.00  

Adjusted conversion price (a)

    $ 0.9759     $ 1.00     $0.675   $ 0.675  

Contractual term to maturity (years)

      2.00       0.49     0.18 – 1.33     0.12  

Expected volatility

      123 %      124 %    90% – 114%     48 % 

Contractual interest rate

      5 %      2 %    1.5% – 5.0%     1.2 % 

Risk-free rate

      0.59 %      0.045 %    0.041% – 0.48%     0.001 % 

Risk adjusted rate

      2.69 %      2.78 %    2.80%     2.80 % 

Probability of event of default

      5.00 %      5.00 %    5.00%     5.00 % 

 

(a) The adjusted conversion price input used in the Binomial Lattice Model considers both (i) the reduction of the conversion price to $0.675 on April 30, 2015, as result of a private placement offering in which Common Stock was sold for a weighted average price of $0.75 and (ii) potential adjustment to the stated conversion price due to a future dilutive issuance. This input was calculated using a probability-weighted approach which considered the likelihood of various scenarios occurring including (i) potential success or failure of various phases for PRO 140, (ii) the probability the Company will enter into a future financing and (iii) and the potential price of a future financing.

The fair value of the derivative liability is significantly influenced by the Company’s trading market price of its stock, stock price volatility, changes in interest, assumptions regarding the adjusted conversion price and early redemption or conversion of the AVCP Notes.