Fair Value Measurements

6 Months Ended

12 Months Ended

Jun. 30, 2023

Dec. 31, 2022

4. Fair Value Measurements

The following table presents the Company’s financial assets and liabilities that are measured at fair value on a recurring basis and the level of inputs used in such measurements (in thousands):


	June 30, 2023
	Balance		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities
Convertible Debentures	$	18,440	$	—	$	—	$	18,440
Derivative liabilities		6,566		—		—		6,566
Other long-term liabilities		169		—		—		169

Total liabilities measured at fair value	$	25,175	$	—	$	—	$	25,175


	December 31, 2022
	Balance		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities
Derivative liabilities	$	1,231	$	—	$	—	$	1,231
Other long-term liabilities		163		—		—		163

Total liabilities measured at fair value	$	1,394	$	—	$	—	$	1,394

Convertible Debentures

In March and April 2023, the Company issued the Convertible Debentures in the principal amount of $25.0 million (see Note 7). The Convertible Debentures are measured at fair value on a recurring basis using Level 3 inputs. The Company uses the Binomial Lattice Model valuation technique to measure the fair value of the convertible debentures with any changes in the fair value of the convertible debentures recorded in the unaudited condensed consolidated statements of operations. Interest expense related to the Convertible Debentures is included in the changes in fair value. As of June 30, 2023, the Company recorded $3.7 million in change in fair value of the convertible debentures. A summary of inputs used in valuing the Convertible Debentures is as follows:


	June 30, 2023
Risk -Free Rate		5.29	%
Corporate Bond Yield		16.33	%
Coupon Interest Rate		7.0	%
Volatility		42.0	%
Dividend Yield		0.0	%
Conversion Price	$	8.00

Derivative Liabilities

The Company recorded a loss of $0.1 million and $2.7 million for the three months ended June 30, 2023 and 2022, respectively, and a loss of $5.3 million and a gain of $4.8 million for the six months ended June 30, 2023 and 2022, respectively, on derivative liabilities which was attributed to the private placement warrants that the Company assumed from Vickers in November 2022 in connection with the Business Combination (“Private Warrants”), and compound derivative liabilities associated with the senior secured notes issued by Scilex Pharma in September 2018 (the “Scilex Pharma Notes”), respectively. At the closing of the Business Combination in November 2022, the Company assumed a derivative warrant liability of $2.5 million related to Private Warrants. The fair value of derivative warrant liability related to Private Warrants was $6.6 million as of June 30, 2023.

The following table includes a summary of the derivative liabilities measured at fair value using significant unobservable inputs (Level 3) during the six months ended June 30, 2023 (in thousands):


	Fair Value
Ending Balance as of December 31, 2022	$	1,231
Change in fair value measurement		5,335

Ending Balance as of June 30, 2023	$	6,566

Warrant Liability Measurement

warrant is the expected volatility of the Common Stock. The expected volatility assumption is based on historical volatilities of comparable companies whose share prices are publicly available as well as the implied volatility of the Public Warrants, described in Note 8 of the Notes to Consolidated Financial Statements in the Annual Report on Form

10-K.

A summary of the inputs used in valuing the derivative warrant liabilities is as follows:


	June 30, 2023			December 31, 2022
Equity value	$	5.57		$	3.99
Exercise price	$	11.50		$	11.50
Term, in years		4.36			4.86
Volatility		55.0	%		35.0	%
Risk-free rate		4.20	%		3.94	%
Dividend yield		0.0	%		0.0	%
Call option value	$	1.60		$	0.30

Contingent Consideration Related to

SP-104

Acquisition

The Development Milestone Payment related to the

SP-104

Assets represents an obligation to potentially settle a fixed value in a variable number of shares of Common Stock and requires remeasurement at fair value through settlement.

Upon the achievement of FDA approval for a new drug application for

SP-104,

the Company will transfer $3.0 million in cash or shares of Common Stock, at the discretion of the Company. The fair value of the contingent consideration liability associated with Development Milestone Payment was estimated using a probability-weighted discounted cash flow method. Significant unobservable inputs assumptions included the likelihood of receiving FDA approval for

SP-104,

expected timing for receipt of FDA approval for

SP-104,

and a discount rate of 10.6%. As of June 30, 2023 and December 31, 2022, the fair value of contingent consideration related to the Development Milestone Payment was $0.2 million.

4. Fair Value Measurements

The following table presents the Company’s financial assets and liabilities that are measured at fair value (in thousands):


	Fair value measurements at December 31, 2022
	Balance		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents	$	2,184	$	2,184	$	—	$	—

Total assets measured at fair value	$	2,184	$	2,184	$	—	$	—

Liabilities
Derivative liabilities	$	1,231	$	—	$	—	$	1,231
Other long-term liabilities		163		—		—		163

Total liabilities measured at fair value	$	1,394	$	—	$	—	$	1,394


	Fair value measurements at December 31, 2021
	Balance		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents	$	4,338	$	4,338	$	—	$	—

Total assets measured at fair value	$	4,338	$	4,338	$	—	$	—

Liabilities
Derivative liabilities	$	35,700	$	—	$	—	$	35,700

Total liabilities measured at fair value	$	35,700	$	—	$	—	$	35,700

Cash and cash equivalents

The Company’s financial assets carried at fair value are comprised of cash and cash equivalents. Cash and cash equivalents consist of money market accounts and bank deposits which are highly liquid and readily tradable. These assets are valued using inputs observable in active markets for identical securities.

Derivative liabilities

The Company recorded a gain of $8.3 million, loss of $0.3 million, and gain of $0.8 million on derivative liabilities for the years ended December 31, 2022, 2021, and 2020, respectively, which was attributed to compound derivative liabilities associated with the Scilex Pharma Notes (see Note 7) and Private Warrants. The fair value of the derivative liability associated with the Scilex Pharma Notes decreased by $30.4 million immediately after entry into Amendment No. 4 (see Note 7) associated with the Scilex Pharma Notes on June 2, 2022. The fair value of the derivative liability associated with the Scilex Pharma Notes was estimated using the discounted cash flow method combined with a Monte Carlo simulation model including consideration of the terms of Amendment No. 4. Significant Level 3 assumptions used in the measurement included a 6.1% risk adjusted net sales forecast and an effective debt yield of 21.5%. The Scilex Pharma Notes were fully extinguished in September 2022 (see Note 7) and, as such, there were no remaining loan derivative liabilities associated with the Scilex Pharma Notes as of December 31, 2022. At the closing of the Business Combination, the Company assumed a derivative warrant liability of $2.5 million related to Private Warrants (See Note 8). The fair value of derivative warrant liability related to Private Warrants was $1.2 million as of December 31, 2022.

The following table includes a summary of the derivative liabilities measured at fair value using significant unobservable inputs (Level 3) during the year ended December 31, 2022:


	Fair value
Ending Balance at December 31, 2019	$	33,400
Loan derivative liability		2,800
Re-measurement of fair value		(800	)

Ending Balance at December 31, 2020	$	35,400
Re-measurement of fair value		300

Balance at December 31, 2021	$	35,700
Private Warrant liability acquired as part of the Business Combination		2,545
Forfeiture of Private Warrants		1,696
Change in fair value measurement		(38,710	)

Balance at December 31, 2022	$	1,231

Warrant Liability Measurement

The derivative warrant liability was valued using the Black-Scholes option pricing model, which is considered to be Level 3 fair value measurement. The primary unobservable input utilized in determining the fair value of the warrant is the expected volatility of the Common Stock. The expected volatility assumption is based on historical volatilities of comparable companies whose share prices are publicly available as well as the implied volatility of the Public Warrants. A summary of the inputs used in valuing the derivative warrant liabilities is as follows:


	December 31, 2022			November 10, 2022
	Fair value			Fair Value
Equity Value	$	3.99		$	9.01
Exercise Price	$	11.50		$	11.50
Term (in years)		4.86			5.00
Volatility		35.0	%		10.0	%
Risk-free rate		3.94	%		3.91	%
Dividend yield		0.00	%		0.00	%
Call option value	$	0.30		$	0.62

Contingent Consideration

The Development Milestone Payment represents a liability under the scope of ASC Topic 480,

Distinguishing Liabilities from Equity

, as it pertains to a potential contractual obligation to settle a fixed value in a variable number of shares of Common Stock. Upon the achievement of FDA approval for a new drug application for

SP-104,

the Company will transfer $3.0 million in cash or shares of Common Stock, at the discretion of the Company. The fair value of the contingent consideration liability associated with Development Milestone Payment was estimated using a probability-weighted discounted cash flow method. Significant Level 3 assumptions included the likelihood of receiving FDA approval for

SP-104,

expected timing for receipt of FDA approval for

SP-104,

and a discount rate of 10.0%. As of December 31, 2022, the fair value of contingent consideration related to the Development Milestone Payment was $0.2 million.

There were no transfers between fair value measurement levels during the years ended December 31, 2022, 2021, and 2020.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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