Notes to Financial Statements
1. The Company and Business Activities
Dermata Therapeutics, Inc., (the “Company”), was formed in December 2014 as a Delaware limited liability company (“LLC”) under the name Dermata Therapeutics, LLC. On March 24, 2021, the Company converted from an LLC to a Delaware C-corporation and changed its name to Dermata Therapeutics, Inc. Any references in these Notes to Financial Statements to equity securities as “units” refer to pre-conversion equity securities and any references to “shares” or “stock” in these Notes to Financial Statements refer to post-conversion equity securities. The Company is a clinical-stage biotechnology company focused on the treatment of medical and aesthetic skin conditions.
2. Liquidity and Going Concern Uncertainty
Since its inception, the Company has not generated any revenue or commercialized any product candidates. As of June 30, 2021, cash totaled $427,202 and the Company had an accumulated deficit of $31,716,498. For the year ended December 31, 2020 and the six months ended June 31, 2021, the Company used cash of $4,028,541 and $1,679,433, respectively, in operations. As a result of the Company’s initial public offering of its common stock and warrants to purchase common stock in August 2021 for gross proceeds of $18 million, before deducting expenses, (see Note 14 – Subsequent Events), the Company’s cash balances are expected to fund operations into October 2022. The Company has not commercialized any product candidates or generated any revenues, and anticipates that it will continue to incur net losses for the foreseeable future. These factors raise substantial doubt about the Company’s ability to continue as a going concern for the one-year period following the date that these financial statements were issued.
Historically, the Company’s principal sources of cash have included proceeds from the issuance of common and preferred equity units and proceeds from the issuance of debt. The Company’s principal uses of cash have included cash used in operations and payments for license rights. The Company expects that the principal uses of cash in the future will be for continuing operations, funding of research and development, conducting preclinical studies and clinical trials, and general working capital requirements. The Company expects that as research and development expenses continue to grow, it will need to raise additional capital to sustain operations and research and development. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
Management’s Plan to Continue as a Going Concern
In order to continue as a going concern, the Company will need, among other things, additional capital resources. Until the Company can generate significant cash from operations, management’s plans to obtain such resources for the Company include proceeds from offerings of the Company’s equity securities or debt, or transactions involving product development, technology licensing or collaboration. Management can provide no assurance that any sources of a sufficient amount of financing will be available to the Company on favorable terms, if at all. The Company has raised additional equity financing through the initial public offering of its common stock and warrants, however management’s current plans do not alleviate substantial doubt about the Company’s ability to continue as a going concern.
3. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, since they are interim statements, the accompanying financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting of normal recurring adjustments) that are necessary for a fair statement of the financial position, results of operations, cash flows, and stockholders' equity for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ materially from those estimates.
Reverse Stock Split
On July 1, 2021, the Company effected a reverse split of shares of the Company’s common stock at a ratio of 1-for-20.5 pursuant to an amendment to the Company’s certificate of incorporation approved by the Company’s board of directors and stockholders. The par value was not adjusted as a result of the reverse split. All issued and outstanding common stock share and per share amounts contained in the financial statements have been retroactively adjusted to reflect this reverse split for all periods presented, and the conversion ratio of the preferred stock was adjusted accordingly.
Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of expenses during the reporting period. On an ongoing basis, management evaluates these estimates and judgments, including those related to accrued research and development expenses and estimated fair values of equity instruments. The Company bases its estimates on various assumptions that it believes are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Segment Information
Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company and the Company’s chief operating decision maker view the Company’s operations and manage its business in one operating segment, which is the business of developing and commercializing pharmaceuticals. The Company operates in only one segment.
Cash
The Company places its cash with reputable financial institutions that are insured by the Federal Deposit Insurance Corporation (“FDIC”). At times, deposits held may exceed the amount of insurance provided by the FDIC. The Company has not experienced any losses in its cash and believes they are not exposed to any significant credit risk.
Fair Value Measurement
The Company uses a three-tier fair value hierarchy to prioritize the inputs used in the Company’s fair value measurements. These tiers include Level 1, defined as observable inputs such as quoted prices in active markets for identical assets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The Company believes the carrying amount of cash, accounts payable, accrued expenses and debt approximate their estimated fair values due to the short-term maturities of these financial instruments.
Fixed Assets
Fixed assets consist of furniture and fixtures and computer equipment. Fixed assets are stated at cost less accumulated depreciation and amortization. Additions, improvements, and major renewals are capitalized. Maintenance, repairs, and minor renewals are expensed as incurred. Depreciation is determined using the straight-line method over the estimated useful lives of the assets, which is primarily three years. Depreciation and amortization expense for the six months ended June 30, 2021 and 2020 were $0 and $322, respectively.
Patent Costs
Patent costs related to obtaining and maintaining patent protection in both the United States and other countries are expensed as incurred. The amounts expensed in the six months ended June 30, 2021 and 2020 were $107,354 and $4,258, respectively, and the amounts expensed in the three months ended June 30, 2021 and 2020 were $20,099 and $2,472, respectively.
Research and Development
Research and development costs consist of expenses incurred in connection with the development of the Company’s product candidates. Such expenses include expenses incurred under agreements with contract research organizations, manufacturing and supply scale-up expenses and the cost of acquiring and manufacturing preclinical and clinical trial supply, outsourced laboratory services, including materials and supplies used to support the Company’s research and development activities, and payments made for license fees and milestones that have not been demonstrated to have commercial value. Such expenses are expensed as incurred. The amounts expensed in the six months ended June 30, 2021 and 2020 were $1,547,785 and $1,373,053, respectively, and the amounts expensed in the three months ended June 30, 2021 and 2020 were $867,197 and $411,949, respectively.
Income Taxes
From inception until March 24, 2021, the Company operated as a limited liability company taxed as a partnership. Therefore, any income tax liability or benefit through that date accrued to our members. After March 24, 2021, the Company operates as a C-Corporation and accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company recognizes net deferred tax assets to the extent that the Company believes these assets are more likely than not to be realized. In making such a determination, management considers all available positive and negative evidence. The Company records the difference between the benefit recognized and measured pursuant to the accounting guidance on accounting for uncertain tax positions taken or expected to be taken on the Company's tax return. The Company records uncertain tax positions on the basis of a two-step process whereby (1) management determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, management recognizes the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority. The liabilities are adjusted in light of changing facts and circumstances, such as the outcome of tax audits. To the extent that the assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. There are no uncertain tax positions.
Stock-Based Compensation
The Company measures and recognizes compensation expense for all stock-based awards made to employees, directors, and non-employees, based on estimated fair values recognized using the straight-line method over the requisite service period.
The fair value of options to purchase common stock granted to employees is estimated on the grant date using the Black-Scholes valuation model. The calculation of stock-based compensation expense requires that the Company make certain assumptions and judgments about a number of complex and subjective variables used in the Black-Scholes model, including the expected term, expected volatility of the underlying common stock and the risk-free interest rate.
Net Loss Per Common Unit/Share
Basic net loss per unit/share is calculated by dividing net loss attributable to common unitholders/shareholders by the weighted-average units/shares outstanding during the period, without consideration of common unit/share equivalents. Diluted net loss per unit/share is calculated by adjusting weighted-average shares outstanding for the dilutive effect of common unit/share equivalents outstanding for the period. For purposes of the diluted net loss per unit/share calculation, preferred units/shares, profit interests, and warrants to purchase preferred units/shares are considered to be common unit/share equivalents but are excluded from the calculation of diluted net loss per common unit/share if their effect would be anti-dilutive.
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
June 30, 2021
|
|
|
June 30, 2020
|
|
|
June 30, 2021
|
|
|
June 30, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,331,792
|
)
|
|
$
|
(821,649
|
)
|
|
$
|
(3,636,700
|
)
|
|
$
|
(2,242,822
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average basic and diluted common units/shares
|
|
|
1,911,009
|
|
|
|
1,911,009
|
|
|
|
1,911,009
|
|
|
|
1,911,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per common unit/share
|
|
$
|
(0.70
|
)
|
|
$
|
(0.43
|
)
|
|
$
|
(1.90
|
)
|
|
$
|
(1.17
|
)
|
The common unit/share equivalents that are not included in the calculation of diluted net loss per common unit/share but could potentially dilute basic earnings per share in the future are as follows:
|
|
|
As of
|
|
|
|
|
June 30, 2021
|
|
|
June 30, 2020
|
|
|
|
|
|
|
|
|
|
|
Series 1 Preferred Units/Shares
|
|
|
336,882
|
|
|
|
336,882
|
|
|
Series 1a Preferred Units/Shares
|
|
|
244,811
|
|
|
|
243,897
|
|
|
Series 1a Prerferred Warrant Units/Shares
|
|
|
69,212
|
|
|
|
70,126
|
|
|
Series 1b Preferred Units/Shares
|
|
|
317,058
|
|
|
|
317,058
|
|
|
Series 1c Preferred Units/Shares
|
|
|
2,270,866
|
|
|
|
2,270,866
|
|
|
Series 1d Preferred Shares
|
|
|
899,046
|
|
|
|
-
|
|
|
Class B Common Units Profits Interests
|
|
|
-
|
|
|
|
362,826
|
|
|
Common Stock Options
|
|
|
398,199
|
|
|
|
-
|
|
|
Common Stock Warrants
|
|
|
65,303
|
|
|
|
-
|
|
|
Total potentially dilutive securities
|
|
|
4,601,337
|
|
|
|
3,601,655
|
|
Recently Adopted Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (“FASB”) issued Account Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. ASU 2019-12 also improves the consistent application, and the simplification, of other areas of Topic 740 by clarifying and amending existing guidance. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years, with early adoption permitted. Adoption of this new guidance on January 1, 2021 did not have an impact on the Company’s financial position and results of operations.
In August 2020, the FASB issued ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in an Entity’s Own Equity (Subtopic 815-40) (“ASU 2020-06”). ASU 2020-06 eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, ASU 2020-06 modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted earnings per share computation. The amendments in ASU 2020-06 are effective for smaller reporting companies as defined by the U.S. Securities and Exchange Commission (“SEC”) for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but not earlier than fiscal years beginning after December 15, 2020. Adoption of this new guidance on January 1, 2021 did not have an impact on the Company’s financial position and results of operations.
4. Balance Sheet Details
The following provides certain balance sheet details:
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
|
|
|
|
|
Prepaid insurance
|
|
$
|
22,334
|
|
|
$
|
68,003
|
|
|
Prepaid clinical trial expense
|
|
|
-
|
|
|
|
7,050
|
|
|
Consulting retainer
|
|
|
9,532
|
|
|
|
-
|
|
|
Deferred offering costs
|
|
|
677,796
|
|
|
|
-
|
|
|
Total prepaid expenses and other current assets
|
|
$
|
709,662
|
|
|
$
|
75,053
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed assets
|
|
|
|
|
|
|
|
|
|
Furniture and office equipment
|
|
$
|
59,382
|
|
|
$
|
59,382
|
|
|
Computer equipment
|
|
|
17,225
|
|
|
|
17,225
|
|
|
|
|
|
76,607
|
|
|
|
76,607
|
|
|
Less: accumulated depreciation and amortization
|
|
|
(76,607
|
)
|
|
|
(76,607
|
)
|
|
Total fixed assets, net
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued and other current liabilities
|
|
|
|
|
|
|
|
|
|
Accrued interest payable
|
|
$
|
4,937
|
|
|
$
|
49,169
|
|
|
Accrued vacation
|
|
|
91,577
|
|
|
|
84,308
|
|
|
Accrued printing and legal costs
|
|
|
490,002
|
|
|
|
-
|
|
|
Total accrued and other current liabilities
|
|
$
|
586,516
|
|
|
$
|
133,477
|
|
5. Subordinated Convertible Promissory Notes
In July and October 2020, the Company issued an aggregate of $3,000,000 of subordinated convertible promissory notes (the “Notes”). Notes in the amount of $1,145,000 were issued to existing investors who are also related parties (See Note - 13 Related Parties), $1,730,000 were issued to existing investors who are not related parties and notes in the amount of $125,000 were issued to new investors. The Notes bear interest at 4% per annum and mature on July 17, 2021.
The Notes are subordinated to the Company’s long-term debt and are convertible into a qualified Series A financing of at least $10 million at a 20% discount to the lowest price per unit paid by investors for that financing. Under authoritative accounting guidance, this contingent beneficial conversion feature will be measured and recognized when the contingency is resolved. The Notes were recorded net of debt discount costs of $28,301. The Company recognized $1,745 and $30,516 of interest expense during the three and six months ended June 30, 2021, respectively, and $78 and $13,970 of amortized debt discount costs during the three and six months ended June 30, 2021, respectively, related to the Notes.
On January 27, 2021, the Company amended the terms of the Notes to increase the maximum amount of convertible promissory notes to be issued from $3,000,000 to $5,000,000, to allow for the conversion of the convertible promissory notes into shares of common upon a Qualified Initial Public Offering with aggregate gross proceeds to the Company of at least $10,000,000 stock at a 20% discount to the lowest price per unit paid by investors for that financing and to extend the maturity date to December 31, 2021. In connection with this amendment, Notes in the amount of $1,255,000 were issued to existing investors who are also related parties (See Note - 13 Related Parties) and $311,000 were issued to existing investors who are not related parties.
In March 2021, the Company further amended the terms of the Notes to allow for the conversion of the Notes into Series 1d Preferred Units at the same price as purchasers of Series 1d Preferred Units. As of March 15, 2021, $4,391,000 of the Notes, along with related interest of $73,801, have been so converted in exchange for 5,379,247 Series 1d Preferred Units. Since the Notes did not convert at a discount, there was no beneficial conversion feature.
The Company considers the above modification of the Notes to be a substantial modification requiring extinguishment accounting under Accounting Standards Codification ("ASC") 470-50-40-10. Based upon an independent valuation of the reacquisition price of the Notes, the difference between the reacquisition price and the net carrying amount of the Notes immediately prior to the modification is not material to the financial statements.
6. Long-Term Debt
In February 2017, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (“SVB”) whereas SVB agreed to provide term loans to the Company in two tranches. The first tranche of $2,500,000 was drawn in February 2017 and bears interest at a rate of 1.5% above the prime rate, which was 3.25% as of December 31, 2020, payable monthly through February 9, 2021. The second tranche was not utilized.
In connection with the Loan and Security Agreement, SVB also received warrant units to purchase, at any time after February 9, 2017 and prior to February 9, 2027, 187,978 Series 1a Preferred Units or the equivalent Series A Preferred Units had they purchased Series 1a Preferred Units, if Series A Preferred Units are issued, at a price of $1.00 per unit. The estimated fair value of these warrant units of $104,630 (See Note 9 Series 1a Warrants Outstanding), as well as costs associated with the term loan, including provision for a final payment of $225,000, was recorded as a discount to outstanding debt and is being amortized to interest expense utilizing the effective interest method over the underlying term of the loan.
In June 2019, the Company and SVB entered into a First Amendment to the Loan and Security Agreement whereby if the Company did not achieve certain capital milestones by December 1, 2019, Term Loan principal payments would be deferred from December 21, 2019 through May 1, 2020 with the deferred principal payments being payable in equal monthly installments, in addition to those principal payments already scheduled to be paid, starting on June 1, 2020 and extending through the February 9, 2021 maturity date of the Term Loan. In addition, if those principal payments were deferred for that six-month period, a non-refundable amendment fee of $100,000 would be due and payable on the earliest to occur of the Maturity Date, the prepayment of the Term Loan or the occurrence of an Event of Default. The capital milestones were not achieved by December 1, 2019 and, therefore, the defined principal repayments were deferred.
The non-refundable amendment fee of $100,000, as well as $12,280 of costs associated with the amendment, have been recorded as a discount to outstanding debt and are being amortized to interest expense utilizing the effective interest method over the remaining underlying term of the loan.
In January and February 2021, the company paid the final principal payments of $231,482 under the SVB Loan and Security Agreement. The Company also paid the final payment fee of $225,000 in February 2021 and the amendment fee of $100,000 in March 2021. No long-term debt is outstanding as of June 30, 2021.
Payroll Protection Program
On April 22, 2020, the Company received proceeds of a $133,592 loan from SVB under provisions of the Small Business Administration Payroll Protection Program (PPP). This loan was forgiven in December 2020 under provisions of the PPP.
7. Equity Securities
Common Stock and Preferred Stock
On March 24, 2021, the Company entered into a Plan of Conversion (“Conversion”) whereby the Company converted from a LLC under the laws of the State of Delaware to a Delaware C-corporation with the name Dermata Therapeutics, Inc. In connection with the Conversion, each fully-paid Preferred and Common Unit in the LLC was converted into a like number of shares of Preferred and Common Stock of the Company with a par value of $0.0001 per share. The Shares issued shall have the same rights, preferences and privileges that had accrued to the pre-converted Units.
Series 1 Preferred Units
From the Company’s formation on December 8, 2014 through 2016, the Company issued 6,906,244 Series 1 Preferred Units for net consideration of $6,833,877.
Series 1a Preferred Units
In 2016, the Company issued 5,000,000 Series 1a Preferred Units in exchange for cash of $5,000,000 and net of issuance costs of $19,868. Purchasers of the Series 1a Preferred Units also received 1,250,000 Warrant Units to purchase an additional amount of Series 1a Preferred Units (see Note 9 – Series 1a Warrants Outstanding). The estimated fair value of the warrant units has been recorded as a separate component of members’ equity (deficit) in the accompanying balance sheet with an offset to the Series 1a proceeds.
Series 1b Preferred Units
In 2018, the Company issued 6,500,000 Series 1b Preferred Units in exchange for cash of $6,500,000 and net of issuance costs of $40,405. Purchasers of the Series 1b Preferred Units also received 26,000,000 Class B Common Units, not representing a profits interest. The estimated fair value of the Class B Common units has been recorded as a component of members’ equity (deficit) in the accompanying balance sheet with an offset to the Series 1b proceeds.
Series 1c Preferred Units
On June 14, 2019, the Company closed participation in a $5,785,000 Series 1c financing from current and new investors. As of December 31, 2019, cash of $5,535,000, including $150,000 from the conversion of a convertible note issued to a Managing Member of the Company for a loan made to the Company, net of issuance costs of $25,857 had been received. The interest on the convertible note in the amount of $1,487 was also converted into Series 1c Preferred units. The remaining balance of $250,000 committed to the financing was paid in the amounts of $125,000 in May and $125,000 in June 2020. In addition, in June 2019 5,221,156 Series 1c Preferred units were issued in connection with the settlement and license agreement.
Series 1d Preferred Units
On March 15, 2021, the Company amended its LLC Agreement to provide for Series 1d Preferred Units at a cost of $0.83 per unit. In March 2021, the Company received proceeds of $570,000 in exchange for the issuance of 686,742 Series 1d Preferred Units.
In addition, as described in Note 5 – Subordinated Convertible Promissory Notes, as of March 15, 2021, $4,391,000 of the Notes, along with related interest of $73,801, have been converted into 5,379,247 Series 1d Preferred Units.
Class A Common Units
During 2014 and 2015, the Company issued 508,777 Class A Common Units in exchange for consideration of $10,430.
Class B Common Units
The Company had 1,767,477 Class B Common Units outstanding as of December 31, 2020. This includes 133,953 Class B Common Units issued for consideration of $2,853 and 1,268,279 Class B Common Units issued in connection with the issuance of the Series 1b Preferred Units, which were assigned an estimated fair value of $2,340,000.
The remaining 365,245 Class B Common Units were issued as a profits interest as that term is defined by Revenue Procedure 93-27, 1993-2 C.B. 343, as clarified by Revenue Procedure 2001-43, 2001-2 C.B. 191, with participation thresholds from $0.001 to $0.36. For performance-based awards, if and when the achievement of the predetermined performance criteria become probable, expense will be recognized. Such units may be issued as vested units or unvested units. Those units designated as Unvested Units were issued with vesting occurring over periods ranging from six to forty- eight months from the date of the award.
During the first quarter 2020, the Company issued 2,439 Class B Common Units, all of which represented a profits interest. During the first quarter of 2021, 22,494 Class B Common Units were forfeited as a result of employee resignations.
Liquidation Preference
So long as there are no Series A Preferred Units outstanding at the time of a liquidity event, any liquidity event proceeds will be distributed as follows: First, the Series 1d Preferred Units have a two times preference in liquidation over the Series 1c Preferred Units and then participate with the Series 1c, 1b and 1a Preferred Units once the Series 1c Preferred Unit preferences have been satisfied. Second, proceeds to Series 1c Preferred Unit holders sufficient to cover two times their Series 1c investment; third, proceeds to Series 1, Series 1a, Series 1b and Series 1c Preferred Unit holders sufficient to cover interest at the rate of 8% per annum on the Series 1 Preferred Units, the Series 1a Preferred Units, the Series 1b Preferred Units and the Series 1c Preferred Units; fourth, proceeds to the Series 1, Series 1a, Series 1b and Series 1c Preferred Unit holders sufficient to cover the unit value of Series 1 Preferred Units, Series 1a Preferred Units, Series 1b Preferred Units and Series 1c Preferred Units; fifth, to Class A and Class B Common holders proceeds sufficient to cover their pro-rata portion of distributions made to Series 1, Series 1a, Series 1b and Series 1c Preferred Unit holders, provided that no Class B Common Units will share in any distribution until after the point at which the amount per Class A Common Unit exceeds the amount of such Class B Common Unit’s Participation Threshold; and sixth, a pro-rata distribution of the remaining proceeds to all equity holders. Upon the issuance of Series A Preferred Units, each Series 1 Preferred Unit, each Series 1a Preferred Unit, each Series 1b Preferred Unit, each Series 1c Preferred Unit and each Series 1d Preferred Unit will automatically convert into the number of Series A Preferred Units equal to the sum of the unit value of the Series 1, Series 1a, Series 1b, Series 1c or Series 1d Preferred Units plus all accumulated preferred return as of the conversion date that would be due with respect to such Series 1, Series 1a, Series 1b, Series 1c or Series 1d Preferred Units in the case of a liquidity event. As of December 31, 2020, no Series A Preferred Units have been issued.
Conversion Rights
Upon the first issuance by the Company of any Series A Preferred Units, each Series 1 Preferred Unit and each Series 1a Preferred Unit and each Series 1b Preferred Unit and each Series 1c Preferred Unit and each Series 1d Preferred Unit shall automatically be converted into the number of Series A Preferred Units equal to the sum of the Unit Value with respect to such Series 1 Preferred Unit or Series 1a Preferred Unit or Series 1b Preferred Unit or Series 1c Preferred Unit or Series 1d Preferred Unit as of the conversion date divided by the product of 0.80 multiplied by the Unit Value of the Series 1 Preferred Units or Series 1a Preferred Units or Series 1b Preferred Units or Series 1c Preferred Units or Series 1d Preferred Unit issued on the conversion date. The Series A Preferred Units issued to the Series 1 Preferred Members and Series 1a Preferred Members and Series 1b Preferred Members and Series 1c Preferred Members and Series 1d Preferred Members upon conversion of such Series 1 Preferred Units and Series 1a Preferred Units and such Series 1b Preferred Units and Series 1c Preferred Units and Series 1d Preferred Units shall have the same rights, privileges and preferences as the other Series A Preferred Units issued by the Company on the conversion date.
The Company considered the classification of the Preferred Units and concluded that they were appropriately included as a component of equity since each class of Preferred Units participates in the same form of consideration received upon a change in control.
Stockholders’ Agreement
On March 24, 2021, in connection with the conversion of Dermata Therapeutics, LLC into a Delaware corporation, the Company entered into a Stockholders’ Agreement (as amended, the Stockholders’ Agreement) with all of its then-existing stockholders, including Proehl Investment Ventures, LLC and Hale Biopharma Ventures, LLC. The Stockholders’ Agreement among other things, provides for certain restrictions on transfer of the Company’s shares of capital stock, sets forth agreements and understandings with respect to how shares of its capital stock held by the stockholders party thereto will be voted on, or tendered in connection with, an acquisition of the Company and to provide for certain voting rights with respect to the election of directors. In addition, pursuant to the Stockholders’ Agreement, holders of the Company’s Series 1a Preferred Stock are entitled to purchase, at any time prior to March 14, 2026, such number of shares of the Company’s Series 1a Preferred Stock as such Series 1a Stockholder shall request, up to an aggregate number of shares of Series 1a Preferred Stock not to exceed the product of 25% and the aggregate number of shares Series 1a Preferred Stock then held by such Series 1a Stockholder (or the Series 1a Preferred Warrant Rights). The shares of Series 1a Preferred Stock purchased pursuant to any Series 1a Preferred Warrant Right has a per share purchase price of $1.00 (subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization). Upon the consummation of the Company’s initial public offering of common stock, each Series 1a Preferred Stock Warrant will be exercisable for the same number of shares of Common Stock with the same per share exercise price of $1.00 per share. The Stockholders’ Agreement will automatically terminate upon the earliest of (a) immediately prior to the consummation of the Company’s initial public offering of common stock, and (b) the consummation of a sale of the Company, subject to certain conditions. Refer to Note 14 - Subsequent Events for discussion of the Company's Initial Public Offering in August 2021.
8. Stock-Based Compensation
Under the Company’s 2021 Omnibus Equity Incentive Plan (the “2021 Plan”), the Company may grant options to purchase common stock, restricted stock awards, performance stock awards, incentive bonus awards, other cash-based awards or directly issue shares of common stock to employees, directors and consultants of the Company. The 2021 Plan provides for the issuance of up to 1,648,213 shares, all of which may, but need not, be issued in respect of Incentive Stock Options. Options may be granted at an exercise price per share of not less than 100% of the fair market value at the date of grant. Options granted are exercisable over a maximum term of 10 years from the date of grant and generally vest over a period of four years.
On March 24, 2021, in connection with the conversion from an LLC to a C-Corporation, the Company converted 277,448 of Series B Common Units profits interests, for which no consideration had been received, into 277,448 options to purchase common stock at an exercise price of $5.74 to $6.314 per share. The Company considers the conversion of these Series B Common Units profits interests as a modification under ASC 718, Stock Compensation, in which the fair value of the Series B Common Units profits interests was measured at the modification date and compared to the fair value of the common stock options, with the difference of $1,339,993 resulting in incremental stock-based compensation expense recorded in the first quarter of 2021.
The Company had also granted Series B Common Units Profits interests to certain former employees and consultants. In connection with the conversion from an LLC to a C-Corporation, the Company converted 65,300 of vested Units to fully vested Common Stock Warrants with an exercise price of $5.74 and an exercise period of 10 years from the date of grant. These Common Stock Warrants issuances were considered a modification under ASC 718, similar to the common stock options discussed in the preceding paragraph. In connection with these grants, the Company recorded $279,812 of stock-based compensation expense in the first quarter of 2021.
As of June 30, 2021, there remain an additional 1,250,000 shares reserved for issuance under the 2021 Plan.
The Company uses the Black-Scholes option valuation model, which requires the use of highly subjectiveassumptions to determine the fair value of stock-based awards. The assumptions used in the Company’s option- pricing model represent management’s best estimates. These estimates are complex, involve a number of variables, uncertainties and assumptions and the application of management’s judgment. If factors change and different assumptions are used, the Company’s stock-based compensation expense could be materially different in the future. The assumptions and estimates that the Company uses in the Black-Scholes model are as follows:
|
|
·
|
Fair Value of Common Stock. The estimated fair value of the common stock underlying the Company’s stock option plan was determined by Management by considering various factors as discussed below. All options to purchase shares of the Company’s common stock are intended to be exercisable at a price per share not less than the per-share fair value of the Company’s common stock underlying those options on the date of grant. In the absence of a public trading market for the Company’s common stock, on each grant date, the Company develops an estimate of the fair value of its common stock based on the information known to the Company on the date of grant, upon a review of any recent events and their potential impact on the estimated fair value per share of the common stock and in part on input from an independent third-party valuation. That estimated fair value of the common stock was $5.74 per share.
|
|
|
|
|
|
|
·
|
Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to that of the expected term of the options for each option group. That risk-free interest rate for the above stock option grants was 0.9%.
|
|
|
|
|
|
|
·
|
Expected Term. The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. Because of the limitations on the sale or transfer of the Company’s common stock as a privately held company, the Company does not believe its historical exercise pattern is indicative of the pattern it will experience as a publicly traded company. The Company plans to continue to use the SAB 110 simplified method until it has sufficient trading history as a publicly traded company. The weighted average expected term of the Company’s stock-based awards is 5.5 years.
|
|
|
|
|
|
|
·
|
Volatility. The Company determines the price volatility based on the historical volatilities of industry peers as it has no trading history for its common stock price. Industry peers consist of several public companies in the biotechnology industry with comparable characteristics, including clinical trials progress and therapeutic indications. The volatility rate used for the above stock option grants was 121%.
|
|
|
|
|
|
|
·
|
Dividend Yield. The expected dividend assumption is based on the Company’s current expectations about its anticipated dividend policy. To date, the Company has not declared any dividends, and therefore the Company has used an expected dividend yield of zero.
|
The weighted average grant date fair value of the Company’s option grants for the six months ended June 30, 2021 is $4.98. As of June 30, 2021, total unrecognized compensation cost related to stock options was $992,538, and the weighted average period over which this cost is expected to be recognized is approximately 2.5 years.
The following table summarizes the total stock-based compensation expense included in the Company's statements of operations for the periods presented:
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
2021
|
|
|
2020
|
|
|
Research and development
|
|
$
|
29,744
|
|
|
$
|
-
|
|
|
$
|
279,971
|
|
|
$
|
-
|
|
|
General and administrative
|
|
|
84,243
|
|
|
|
-
|
|
|
|
994,065
|
|
|
|
-
|
|
|
|
|
$
|
113,987
|
|
|
$
|
-
|
|
|
$
|
1,274,036
|
|
|
$
|
-
|
|
The following table summarizes the stock option activity for the six and three months ended June 30, 2021:
|
|
|
Number
of Shares
|
|
|
Weighed Average
Exercise Price Per
Share
|
|
|
Weighted Average
Remaining Contract
Term
|
|
|
Weighted Average
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2020
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Granted
|
|
|
398,199
|
|
|
$
|
5.83
|
|
|
|
9.3
|
|
|
$
|
0.00
|
|
|
Cancelled/Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Outstanding at March 31, 2021
|
|
|
398,199
|
|
|
$
|
5.83
|
|
|
|
9.3
|
|
|
$
|
0.00
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Cancelled/Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Outstanding at June 30, 2021
|
|
|
398,199
|
|
|
$
|
5.83
|
|
|
|
9.0
|
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and exercisable at June 30, 2021
|
|
|
209,915
|
|
|
$
|
5.76
|
|
|
|
9.6
|
|
|
$
|
0.00
|
|
9. Series 1a Warrants Outstanding
In connection with the issuance of 5,000,000 Series 1a Preferred Units in November, 2016, each Series 1a Preferred Member received Warrant Units to purchase from the Company, at any time after November 15, 2016 and on or prior to November 15, 2021, such number of Series 1a Preferred Units as such Series 1a Preferred Member shall request, up to an aggregate number of Series 1a Preferred Units not to exceed the product of 25% and the aggregate number of Series 1a Preferred Units then held by such Series 1a Preferred Member, which is 1,231,250 units at December 31, 2020. The exercise price for each Warrant Unit is $1.00, subject to adjustment for unit splits and combinations. The warrant has a 5-year term. The Company received total proceeds of $5,000,000 for the Series 1a Preferred Units and warrants which were allocated on a relative fair value basis to the Units and warrants resulting in a relative fair value of $4,381,199 and $618,801, respectively. The estimated fair value of the Series 1a Warrant Units is recorded as a separate component of members’ equity (deficit) in the accompanying financial statements. In June 2020, 18,750 of the warrants were exercised for consideration of $18,750, which consideration was received in July 2020.
In connection with the Loan and Security Agreement, SVB also received Warrant Units to purchase, at any time after February 9, 2017 and prior to February 9, 2027, 187,978 Series 1a Preferred Units or the equivalent Series A Preferred Units had they purchased Series 1a Preferred Units, if Series A Preferred Units are issued, at an exercise price of $1.00 per unit.
In connection with the Conversion (See Note 7 – Equity Securities), each warrant to purchase Series 1a Preferred Units in the LLC were automatically converted into a warrant to purchase, upon the same terms and conditions, shares of Series 1a Preferred Stock of the Company.
10. 401(k) Plan
The Company sponsors a 401(k) savings plan for all eligible employees. The Company may make discretionary matching contributions to the plan to be allocated to employee accounts based upon employee deferrals and compensation. To date, the Company has not made any matching contributions into the savings plan.
11. License Agreements
On March 31, 2017, the Company entered into a license agreement, as amended (“The License Agreement”) with Villani, Inc. (“Villani”) whereby Villani has granted the Company an exclusive, sub-licensable, royalty- bearing license (“The License”) under the Licensed Patents (as defined in the License Agreement), to formulate, develop, seek regulatory approval for, make or sell products that contain Spongilla lacustris (alone or in combination with other active or inactive ingredients) for the treatment of diseases, disorders and conditions of the skin, including but not limited to acne, rosacea, psoriasis, atopic dermatitis, seborrheic dermatitis, actinic keratosis and eczema that were developed using certain licensed know-how (“The Licensed Products”). The Company is responsible for the development (including manufacturing, packaging, non-clinical studies, clinical trials and obtaining regulatory approval and commercialization (including marketing, promotion, distribution, etc.)) for all Licensed Products.
In partial consideration of the License, the Company forgave a previous outstanding loan to Villani in the amount of $400,000. The License was amended in 2019 and, in consideration of the receipt of certain know-how and patents, the Company issued to Villani 5,221,156 Series 1c Preferred Units equal to 5% of the Company’s fully diluted capitalization, valued at $730,962. Pursuant to the License Agreement, the Company is required to make future milestone payments to Villani in an aggregate amount of up to $20.25 million upon the achievement of specified development and sales milestones, payable in cash or in equity, at the option of Villani. If the Company sublicenses the License, the Company is obligated to pay to Villani a sublicense fee of between 5% and 15% of Sublicense revenues (as defined in the License Agreement) received by the Company.
Pursuant to the License Agreement, the Company is required to make royalty payments to Villani in amounts equal to a single-digit percentage of net sales of Licensed Products and HMW Combination Products (as defined in the License Agreement), subject to certain adjustments as set forth in the License Agreement. Royalties shall be payable, on a country-by-country and Licensed Product-by Licensed Product basis, for the period of time from the effective date of the License Agreement until the later of (i) the expiration of the last to expire valid claim in such country (which is set to expire in 2023), (ii) the expiration of regulatory exclusivity for such Licensed Product in such country, and (iii) 15 years from the date of the first commercial sale of the Licensed Product in such country.
The License Agreement may be terminated (i) by either party for material breach with 90 days written notice, or 30 days’ notice if for material payment breach, if such material breach is not cured within such notice period, (ii) immediately upon written notice to either party if either party initiates a voluntary bankruptcy proceeding, dissolves or winds-up its business, (iii) immediately upon written notice to either party if either party becomes subject to involuntary bankruptcy proceedings, if such proceedings are not dismissed or stayed within 90 days.
The License agreement includes customary terms relating to, among others, indemnification, intellectual property protection, confidentiality, remedies and warranties.
Refer to Note 14 - Subsequent Events for discussion of the Second Amendment to the License and Settlement Agreement.
12. Commitments and Contingencies
Coronavirus Pandemic
On March 11, 2020, the World Health Organization declared the outbreak of a coronavirus (COVID-19) pandemic. Significant uncertainties may arise with respect to potential shutdowns of operations or government orders to cease activities due to emergency declarations, inability to operate, or employee shortages, claims for business interruption insurance, etc. Each of these matters may have a significant impact on the future results of the Company.
Legal Proceedings
In the normal course of business, the Company may be involved in legal proceedings or threatened legal proceedings. The Company is not a party to any legal proceedings or aware of any threatened legal proceedings which are expected to have a material adverse effect on its financial condition, results of operations or liquidity.
On July 30, 2021, the Company entered into a Second Amendment to the License and Settlement Agreement. Refer to Note 14 -Subsequent Events for further discussion.
13. Related Parties
During 2020, the Managing Members and other related parties to the Company loaned the Company $1,145,000 of subordinated convertible promissory notes as described in Note 5 – Subordinated Convertible Promissory Notes. During the six-months ended June 30, 2021, a Managing Member and other related parties to the Company loaned the company $1,255,000 of subordinated convertible promissory notes as described in Note 5 – Subordinated Convertible Promissory Notes.
14. Subsequent Events
On June 29, 2021, with effectiveness on July 1, 2021, the Company’s board of directors amended its Certificate of Incorporation to adjust the conversion price and certain conversion mechanics of the Company’s issued and outstanding Series 1d Preferred Stock, whereby each share of Series 1d Preferred stock will convert into such number of Common Stock as determined by dividing (i) the product of (a) the Original Issue Price for the Series 1d Preferred Stock, multiplied by (b) 1.2, rounded to the nearest whole cent, by (ii) the 80% of the initial public per share offering price in the IPO. The Series 1d conversion shall not be subject to further adjustment for any stock split.
On June 29, 2021, with effectiveness on July 1, 2021, the Company’s board of directors approved an amendment to the 2021 Plan to increase the number of shares of Common Stock available for issuances from 593,340 to 1,648,213 shares.
On June 29, 2021, the Company’s board of directors approved a 1-for-20.5 reverse split of all outstanding shares of common stock, effected on July 1, 2021 (no fractional shares were issued). Except as otherwise noted, all references to share and per share amounts related to common stock and common units have been restated to reflect the reverse stock split.
On July 8, 2021, the Company’s board of directors amended its Certificate of Incorporation to adjust the conversion price and certain conversion mechanics of the Company’s issued and outstanding Series 1d Preferred Stock, whereby each share of Series 1d Preferred Stock is convertible into such number of fully paid and nonassessable shares of Common Stock as is determined by multiplying the Adjusted As Converted Number (as defined below) by the Series 1d IPO Conversion Ratio (as defined below) (the “Series 1d IPO Conversion Number”. For the avoidance of doubt, and not withstanding the terms set forth in Section 3.4, the Series 1d IPO Conversion Number shall not be subject to further adjustment for any subdivision or combination of the outstanding Common Stock effected in anticipation of the IPO.
|
|
(a)
|
The “Adjusted Conversion Price” means the product of (i) the Original Issue Price for the Series 1d Preferred Stock multiplied by (ii) 1.2, rounded to the nearest whole cent.
|
|
|
|
|
|
|
(b)
|
The “Adjusted Conversion Ratio” means the quotient of (i) the Original Issue Price for the Series 1d Preferred Stock divided by (ii) the Adjusted Conversion Price.
|
|
|
|
|
|
|
(c)
|
The “Adjusted As Converted Number” means the product of (i) one share of Series 1d Preferred Stock multiplied by (ii) the Adjusted Conversion Ratio.
|
|
|
|
|
|
|
(d)
|
The “IPO Discount Ratio” means 80% of the initial public per share offering price in the IPO.
|
|
|
|
|
|
|
(e)
|
The “Series 1d IPO Conversion Ratio” means the quotient of (i) the Adjusted Conversion Price divided by (ii) the IPO Discount Price.
|
On July 30, 2021, the Company entered into a Second Amendment to the License and Settlement Agreement (or, the Second License Amendment), whereby, for the settlement of certain disputes arising under the First License Amendment, the Company agreed to exchange the shares of Series 1c Preferred Stock owned by Villani for an increase of milestone payments and royalty rates due to Villani under the License Agreement. The resulting royalty rates payable pursuant to the Second License Amendment are equal to single-digit percentages of net sales of Licensed Products and HMW Combination Products (as defined in the License Agreement), subject to certain adjustments as set forth in the Second License Amendment. Royalties are payable on a country-by-country and Licensed Product-by-Licensed Product basis, for the period of time from the effective date of the License Agreement until the later of (i) the expiration of the last to expire valid claim in such country (which is set to expire in 2023), (ii) the expiration of regulatory exclusivity for such Licensed Product in such country, and (iii) 15 years from the date of the first commercial sale of the Licensed Product in such country. Pursuant to the Second License Amendment, if the Company sublicenses the License, it is obligated to pay to Villani a sublicense fee of between 10% and 30% of Sublicense Revenues (as defined in the License Agreement). Such future milestone payments due to Villani (all payable to Villani in cash or in equity, at the option of Villani) are in aggregate amounts of up to $3.5 million in development milestones and $37.0 million in sales milestones. On August 17, 2021, the Company paid to Villani $1.0 million upon the close of the Company's initial public offering. The Company also agreed to use Commercially Reasonable Efforts (as defined in the Second License Agreement) to initiate certain development activities.
On August 14, 2021, the Company's board of directors approved an amendment to the Company's Certificate of Incorporation to increase the number of shares of Common Stock authorized to 90,000,000.
On August 17, 2021, the Company closed its initial public offering of 2,571,428 shares of its common stock. Each share of common stock was sold together with one warrant to purchase one share of common stock with an exercise price of $7.00 per share at a combined offering price of $7.00, for gross proceeds of approximately $18.0 million, before deducting underwriting discounts and offering expenses. In addition, the underwriters exercised their option to purchase an additional 385,714 warrants.