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

Quarterly report pursuant to Section 13 or 15(d)

Derivative Liabilities

Derivative Liabilities

3 Months Ended

Aug. 31, 2020

Note 6 – 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 warrant holder 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,

Distinguishing Liabilities from Equity

, and ASC 815,

Derivatives and Hedging,

and are recorded at fair value. All of the investors and placement agent warrants were exercised during the fiscal year ending May 31, 2020.

The following tables summarize the fair value of the warrant derivative liability and related common shares as of inception date September 15, 2016, prior fiscal year end date May 31, 2020 and current reporting date August 31, 2020 (in thousands):


	Shares Indexed		Derivative Liability
Inception to date September 15, 2016		7,733	$	5,179
Change in fair value of derivative liability		—		(4,777	)

Balance May 31, 2019		7,733		402
Change in fair value of derivative liability		—		11,547
Fair value of warrants exercised		7,733		(11,949	)

Balance May 31, 2020		—		—
Change in fair value of derivative liability		—		—
Balance August 31, 2020		—	$	—

Changes in the fair value of the derivative liability are reported as “Change in fair value of derivative liability” in the Consolidated Statements of Operations. The Company recognized approximately $0.1

million

non-cash

gain

, due to the changes in the fair value of the liability associated with such classified warrants during the three months ended August 31, 2019.

ASC 820,

Fair Value Measurement

, 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 valuation model.

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


	September 15, 2016			May 31, 2019			August 31, 2019
Fair value of underlying stock	$	0.78		$	0.39		$	0.40
Risk free rate		1.20	%		1.94	%		1.50	%
Expected term (in years)		5			2.29			2.04
Stock price volatility		106	%		61	%		60	%
Expected dividend yield		—			—			—
Probability of f undamental t ransaction		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 5 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 November 15, 2018, January 30, 2019 and August 31, 2019:


							August 31, 2019
	November 15, 2018			January 30, 2019			June Note			January Note
Fair value of underlying stock	$	0.57		$	0.49		$	0.40		$	0.40
Risk free rate		2.78	%		2.52	%		1.76	%		1.76	%
Expected term (in years)		1.61			2			0.82			1.42
Stock price volatility		58.8	%		61	%		63.8	%		61.6	%
Expected dividend yield		—			—			—			—
Discount factor		85	%		85	%		85	%		85	%

As discussed above, the June 2018 and January 2019 Notes were fully satisfied during the fiscal year ended May 31, 2020 and there is no outstanding balance as of August 31, 2020.

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 August 31, 2019 (in thousands):


	Net Proceeds		Derivative Liability
	Net Proceeds		Inception date		August 31, 2019
Inception date June 2018 Note, November 15, 2018	$	5,000	$	1,285	$	373
Inception date January 2019 Note, January 30, 2019		5,000		1,465		1,070

					$	1,443

The Company recognized approximately $0.6

million

non-cash

gain, due to the changes in the fair value of the liability associated with such classified redemption provision for the three months ended August 31, 2019.

There was no gain or loss for the three months ended August 31, 2020.