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Note 10 - Convertible Notes
 3 Months Ended
Mar. 31, 2024
Notes to Financial Statements  
Debt Disclosure [Text Block]

NOTE 10. CONVERTIBLE NOTES

 

Unsecured Convertible Note

 

In March 2024, the Company issued $525 thousand aggregate principal amount unsecured convertible notes (the “Unsecured Convertible Notes”) in conjunction with the 2024 Subsidiary Guarantee Termination. The 2024 Subsidiary Guarantee Termination was executed with certain holders of the Secured Convertible Notes in order to close the DERMAdoctor Divestiture (see additional discussion in Note 9, “Financing Activities” and Note 17, “Divestiture and Discontinued Operations”). The Unsecured Convertible Notes are due March 25, 2026 and bear no stated interest.

 

The Unsecured Convertible Notes may be converted or redeemed for a conversion price equal to $0.14 per share at any time beginning on the date that the Company’s stockholders approve the conversion of up to the aggregate principal amount of all of the Unsecured Convertible Notes. Any such conversion is at the election of individual holders up to the amount of outstanding principal at the time of conversion subject to certain limitations such as beneficial ownership limitations. Upon stockholder approval, the Unsecured Convertible Notes will be convertible for up to 3,750,000 shares of common stock. If stockholder approval is not obtained by September 25, 2024, the Unsecured Convertible Notes will become immediately due and payable.

 

Upon issuance in March 2024, the lender’s conversion option under the Unsecured Convertible Notes represented an embedded call option requiring bifurcation as an embedded derivative liability because the common stock underlying the option required stockholder approval before the option could be exercised. The fair value of the embedded derivative was determined to be $224 thousand as of the date of issuance in accordance with a Black Scholes valuation model. See also Note 3, “Fair Value Measurements”, subheading “Black Scholes Valuation Model Assumptions”. Upon stockholder approval of conversion of the notes, the embedded call option will no longer require liability treatment and will be reclassified to equity. The fair value of the embedded derivative liability was determined to be $159 thousand as of March 31, 2024. The change of $65 thousand in fair value between the date of issuance and as of March 31, 2024 was recorded as a non-cash gain on change in fair value of embedded derivative liability in the condensed consolidated statements of operations. See also Note 3, “Fair Value Measurements”, subheading “Black Scholes Valuation Model Assumptions”.

 

The discount to the note recorded for the embedded derivative liability upon issuance and debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Unsecured Convertible Notes, assuming that the Unsecured Convertible Notes will be redeemed for cash of $525 thousand at time of maturity as of March 25, 2026. During the three month period ended March 31, 2024, the effective interest rate on the Unsecured Convertible Notes was 144%. During the three month period ended March 31, 2024, interest expense recognized, including amortization of the issuance costs and debt discount, was nominal, which was included in other expense, net in the condensed consolidated statements of operations.

 

Secured Convertible Note

 

In May 2023, the Company issued $3.3 million aggregate principal amount Original Issue Discount Senior Secured Convertible Debentures (the “Secured Convertible Notes”) in conjunction with the 2023 Private Placement (see Note 9, “Financing Activities”). The Secured Convertible Notes were issued with a $300 thousand original issue discount. The Secured Convertible Notes are due November 1, 2024.

 

The Secured Convertible Notes may be converted or redeemed for a conversion price equal to $1.30 per share at any time at the election of the holder up to the amount of outstanding principal at the time of conversion subject to certain limitations such as beneficial ownership limitations. Upon issuance, the Secured Convertible Notes were convertible for up to 2,538,464 shares of common stock. As of March 31, 2024, the Secured Convertible Notes were convertible for up to 1,030,944 shares of common stock.

 

Beginning June 1, 2023, the Company was required to start making a monthly redemption of 1/18th of the original principal amount of the Secured Convertible Notes. Each monthly redemption reduces the outstanding principle of the Secured Convertible Note by $183 thousand and may be made in cash or, under limiting conditions, in stock at the election of the Company. Monthly redemption in cash requires a total payment of $193 thousand. Monthly redemption in stock requires the issuance of shares equal to $193 thousand divided by the lower of (i) $1.30 or (ii) 90% of the Company’s common stock’s average volume-weighted average price over 10 trading days prior to the redemption. The conditions allowing for redemption in stock have not been met through March 31, 2024 and the Company has made all monthly redemption payments in cash.

 

The Secured Convertible Notes also provide for a redemption equal to up to 20% of the gross proceeds received by the Company from any financing completed while the Secured Convertible Notes are outstanding. In connection with the 2023 Warrant Reprice Transaction (see Note 12, “Stockholders’ Equity”), the Company made such a payment totaling $126 thousand in cash against the Secured Convertible Notes.

 

If any event of default occurs, the outstanding principal amount of the Secured Convertible Notes, plus accrued but unpaid interest, liquidated damages and other amounts owing thereof become immediately due and payable in cash at the holder’s election. After any event of default, the Secured Convertible Notes will also accrue interest at a rate up to 18% per year. The Secured Convertible Notes are secured obligations of the Company including a security interest, a lien upon and a right of set-off against all of the Company’s assets as collateral security. DERMAdoctor was released of such obligations in connection with the DERMAdoctor Divestiture.

 

Upon issuance in May 2023, the lender’s conversion option under the Secured Convertible Notes represented an embedded call option requiring bifurcation as an embedded derivative liability because the common stock underlying the option required stockholder approval before the option could be exercised. The fair value of the embedded derivative was determined to be $209 thousand as of the date of issuance. After stockholder approval of the underlying common stock, the embedded call option no longer required liability treatment and was reclassified to equity. The fair value of the embedded derivative liability was determined to be $169 thousand upon stockholder approval. The change of $40 thousand in fair value between the date of issuance and stockholder approval was recorded as a non-cash gain on change in fair value of embedded derivative liability in the consolidated statements of operations. See also Note 3, “Fair Value Measurements”, subheading “Black Scholes Valuation Model Assumptions”.

 

The lender’s subsequent financing redemption option and certain events of default also represent embedded call options and the Company’s monthly share redemption option represents an embedded put option. The fair value of these options was determined to be immaterial upon issuance and at each subsequent reporting date.

 

The Company allocated $1.2 million of gross proceeds from the 2023 Private Placement to the Secured Convertible Notes.

 

The difference between the $1.2 million allocated to the Secured Convertible Notes and the $3.3 million aggregate principal amount represent discounts for the portion of proceeds allocated to the embedded derivative liability and the May 2023 Warrants (See Note 11, “Common Stock Warrants”) as well as the $0.3 million original issue discount. The Company also allocated $0.3 million of debt issuance costs to the Secured Convertible Notes.

 

The discounts and debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Secured Convertible Notes, assuming that the Secured Convertible Notes will be redeemed for cash of $193 thousand per month beginning in June 2023. The effective interest rate on the Secured Convertible Notes was 173%. During the three months ended March 31, 2024, interest expense recognized, including amortization of the issuance costs and debt discount, was $0.4 million, which was included in other expense, net in the condensed consolidated statements of operations.

 

The Secured Convertible Notes are presented as follows as of March 31, 2024 (in thousands):

 

Principal amount

 $1,314 

Unamortized discount for proceeds allocated to embedded derivative liability and May 2023 Warrants

  (293)

Unamortized debt issuance costs

  (48)

Total Secured Convertible Notes, net

 $973 

 

The Secured Convertible Notes, net, are classified as short term in the Company’s condensed consolidated balance sheets.

 

As of March 31, 2024, the Company’s contractual maturity of the principal balance of the Secured Convertible Notes was as follows (in thousands):

 

2024

 $1,314