ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Statement Presentation

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto as of and for the year ended December 31, 2015 included in the Apricus Biosciences, Inc. and subsidiaries (the “Company”) Annual Report on Form 10-K (“Annual Report”) filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 9, 2016. The accompanying financial statements have been prepared by the Company 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, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. In the opinion of management, the accompanying condensed consolidated financial statements for the periods presented reflect all adjustments, consisting of only normal, recurring adjustments, necessary to fairly state the Company’s financial position, results of operations and cash flows. Certain prior year items have been reclassified to conform to the current year presentation. The December 31, 2015 condensed consolidated balance sheet was derived from audited financial statements, but does not include all GAAP disclosures. The unaudited condensed consolidated financial statements for the interim periods are not necessarily indicative of results for the full year. The preparation of these unaudited condensed consolidated financial statements requires the Company to make estimates and judgments that affect the amounts reported in the financial statements and the accompanying notes. The Company’s actual results may differ from these estimates under different assumptions or conditions.

Liquidity

The accompanying consolidated financial statements have been prepared on a basis which assumes the Company is a going concern and that contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company had an accumulated deficit of approximately $314.7 million as of June 30, 2016 and reported a net loss of approximately $5.8 million and negative cash flows from operations for the six months ended June 30, 2016. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company has principally been financed through the sale of its common stock and other equity securities, debt financings and up-front payments received from commercial partners for the Company’s products under development. As of June 30, 2016, the Company had cash and cash equivalents of approximately $2.7 million.

In July 2016, the Company and Aspire Capital Fund, LLC (“Aspire Capital”) entered into a Common Stock Purchase Agreement (the “Aspire Purchase Agreement”), which provides that Aspire Capital is committed to purchase, if the Company chooses to sell and at the Company’s discretion, an aggregate of up to $7.0 million of shares of the Company’s common stock over the 24-month term of the Aspire Purchase Agreement. The Aspire Purchase Agreement can be terminated at any time by the Company by delivering notice to Aspire Capital. On July 5, 2016 (the “Aspire Closing Date”), the Company delivered to Aspire Capital a commitment fee of 1,518,987 shares of the Company’s common stock at a value of $0.6 million, in consideration for Aspire Capital entering into the Aspire Purchase Agreement. Additionally, on the Aspire Closing Date, the Company sold 2,531,645 shares of the Company’s common stock to Aspire Capital for proceeds of $1.0 million. Pursuant to the Aspire Purchase Agreement, the Company and Aspire Capital terminated the prior Common Stock Purchase Agreement, dated August 12, 2014, between the parties. See footnote 6 for more discussion of the Aspire Purchase Agreement.

In January 2016, the Company entered into subscription agreements with certain purchasers pursuant to which it agreed to sell an aggregate of 11,363,640 shares of its common stock and warrants to purchase up to an additional 5,681,818 shares of its common stock to the purchasers for an aggregate offering price of $10.0 million, to take place in separate closings. Each share of common stock was sold at a price of $0.88 and included one half of a warrant to purchase a share of common stock. The warrants have an exercise price of $0.88 per share, become exercisable six months and one day after the date of issuance and will expire on the seventh anniversary of the date of issuance. During the first closing in January 2016, the Company sold an aggregate of 2,528,411 shares and warrants to purchase up to 1,264,204 shares of common stock for gross proceeds of $2.2 million. The remaining shares and warrants were sold in a subsequent closing in March 2016 for gross proceeds of $7.8 million following stockholder approval at a special meeting on March 2, 2016.

In October 2014, the Company entered into the Loan and Security Agreement (the “Credit Facility”) with Oxford Finance LLC (“Oxford”) and Silicon Valley Bank (“SVB”) (Oxford and SVB are referred to together as the “Lenders”), which is secured by substantially all of the Company’s assets, excluding intellectual property. Upon closing, a $5.0 million term loan was funded. In July 2015, the Company borrowed the remaining $5.0 million available under its Credit Facility with the Lenders. The principal balance under the Credit Facility was $8.0 million as of June 30, 2016.

The Company currently has an effective shelf registration statement on Form S-3 (No. 333-198066) filed with the Securities and Exchange Commission (“SEC”) under which it may offer from time to time any combination of debt securities, common and preferred stock and warrants. As of June 30, 2016, the Company had approximately $79.0 million available under its Form S-3 shelf registration statement. Under current SEC regulations, at any time during which the aggregate market value of the Company’s common stock held by non-affiliates (“public float”), is less than $75.0 million, the amount it can raise through primary public offerings of securities in any twelve-month period using shelf registration statements, including sales under the Aspire Purchase Agreement, is limited to an aggregate of one-third of the Company’s public float. SEC regulations permit the Company to use the highest closing sales price of the Company’s common stock (or the average of the last bid and last ask prices of the Company’s common stock) on any day within 60 days of sales under the shelf registration statement. As of June 30, 2016, the Company’s public float was approximately $23.6 million based on 47.1 million shares of the Company’s common stock outstanding at a price of $0.50 per share, which was the closing sale price of the Company’s common stock on May 2, 2016. Since the Company’s public float was less than $75.0 million as of June 30, 2016, the Company may only sell approximately $7.8 million of securities under its shelf registration statements on Form S-3 including any amounts sold through the Aspire Purchase Agreement. The Company still maintains the ability to raise funds through other means, such as through the filing of a registration statement on Form S-1 or in private placements. The rules and regulations of the SEC or any other regulatory agencies may restrict the Company’s ability to conduct certain types of financing activities, or may affect the timing of and amounts it can raise by undertaking such activities.

The accompanying consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and settlement of liabilities in the normal course of business, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from uncertainty related to its ability to continue as a going concern.

The Company’s future liquidity and capital funding requirements will depend on numerous factors, including:


•	its ability to raise additional funds to finance its operations and service its debt;


•	the revenue generated by product sales and royalty revenue from the Company’s Vitaros^® commercialization partners;


•	the revenue generated by component sales to the Company’s contract manufacturers;


•	its ability to successfully implement its cost-reduction plan as part of a broader strategic re-positioning toward Vitaros^®


•	the outcome, costs and timing of clinical trial results for its product candidate;


•	the emergence and effect of competing or complementary products;


•	its ability to maintain, expand and defend the scope of its intellectual property portfolio, including the amount and timing of any payments the Company may be required to make, or that it may receive, in connection with the licensing, filing, prosecution, defense and enforcement of any patents or other intellectual property rights;


•	its ability to retain its current employees and the need and ability to hire additional management and scientific and medical personnel;


•	the terms and timing of any collaborative, licensing or other arrangements that it has or may establish;


•	the trading price of the Company’s common stock being above the $0.10 closing floor price that is required for the Company to use the committed equity financing facility with Aspire Capital;


•	the trading price of its common stock; and


•	its ability to maintain compliance with the listing requirements of The NASDAQ Capital Market.

In order to fund its operations during the next twelve months, the Company will need to raise substantial additional funds through one or more of the following: issuance of additional debt or equity, accessing additional capital under its committed equity financing facility with Aspire Capital, as described above or the completion of a licensing transaction for one or more of the Company’s pipeline assets. If the Company is unable to maintain sufficient financial resources, its business, financial condition and results of operations will be materially and adversely affected. This could affect future development activities, such as the resubmission of a Vitaros^® United States new drug application (“NDA”), continued development of Room Temperature Vitaros^®, as well as future clinical studies for RayVa^™. There can be no assurance that the Company will be able to obtain the needed financing on acceptable terms or at all. Additionally, equity or debt financings may have a dilutive effect on the holdings of the Company’s existing stockholders.

Warrant Liabilities

The Company’s outstanding common stock warrants issued in connection with its February 2015 and January 2016 financings are classified as liabilities in the accompanying condensed consolidated balance sheets as they contain provisions that require the Company to maintain active registration of the shares underlying such warrants, which is considered outside of the Company’s control. The warrants were recorded at fair value using the Black-Scholes option pricing model. The fair value of these warrants is re-measured at each financial reporting period with any changes in fair value being recognized as a component of other income (expense) in the accompanying condensed consolidated statements of operations.

Fair Value Measurements

The Company determines the fair value measurements of applicable assets and liabilities based on a three-tier fair value hierarchy established by accounting guidance and prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted market prices in active markets; 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’s common stock warrant liabilities are measured and disclosed at fair value on a recurring basis, and are classified within the Level 3 designation. None of the Company’s non-financial assets and liabilities are recorded at fair value on a non-recurring basis.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following table presents the Company’s fair value hierarchy for its warrant liabilities measured at fair value on a recurring basis (in thousands) as of June 30, 2016 and December 31, 2015:



	Quoted Market Prices for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Warrant liabilities
Balance as of June 30, 2016	$	—	$	—	$	2,211	$	2,211
Balance as of December 31, 2015	$	—	$	—	$	1,841	$	1,841

The common stock warrant liabilities are recorded at fair value using the Black-Scholes option pricing model. The following assumptions were used in determining the fair value of the common stock warrant liabilities valued using the Black-Scholes option pricing model as of June 30, 2016 and December 31, 2015:



	June 30, 2016			December 31, 2015
Risk-free interest rate	1.08		%	1.82		%
Volatility	85.71%-88.67%			83.00		%
Dividend yield	—		%	—		%
Expected term	6.54-6.68			6.13
Weighted average fair value	$	0.25		$	0.61

The following table is a reconciliation for all liabilities measured at fair value using Level 3 unobservable inputs (in thousands):



	Warrant liability
Balance as of December 31, 2015	$	1,841
Issuance of warrants in connection with January 2016 financing	4,807
Change in fair value measurement of warrant liability	(5,113		)
Repricing of February 2015 warrants in connection with January 2016 financing	676
Balance as of June 30, 2016	$	2,211

Of the inputs used to value the outstanding common stock warrant liabilities as of June 30, 2016, the most subjective input is the Company’s estimate of expected volatility.

Revenue Recognition

The Company generates revenues from licensing technology rights and the sale of products. The Company recognizes revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the Company’s price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.

Payments received under commercial arrangements, such as licensing technology rights, may include non-refundable fees at the inception of the arrangements, milestone payments for specific achievements designated in the agreements, and royalties on the sale of products. The Company considers a variety of factors in determining the appropriate method of accounting under its license agreements, including whether the various elements can be separated and accounted for individually as separate units of accounting. Deliverables under the arrangement will be separate units of accounting, provided (i) a delivered item has value to the customer on a standalone basis; and (ii) the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the Company’s control.

Multiple Element Arrangements

The Company accounts for revenue arrangements with multiple elements by separating and allocating consideration according to the relative selling price of each deliverable. If an element can be separated, an amount is allocated based upon the relative selling price of each element. The Company determines the relative selling price of a separate deliverable using the price it charges other customers when it sells that product or service separately. If the product or service is not sold separately and third party pricing evidence is not available, the Company will use its best estimate of selling price.

Milestones

Revenue is recognized when earned, as evidenced by written acknowledgment from the collaborator or other persuasive evidence that the milestone has been achieved, provided that the milestone event is substantive. A milestone event is considered to be substantive if its achievability was not reasonably assured at the inception of the arrangement and the Company’s efforts led to the achievement of the milestone (or if the milestone was due upon the occurrence of a specific outcome resulting from the Company’s performance). Events for which the occurrence is either contingent solely upon the passage of time or the result of a counterparty’s performance are not considered to be milestone events. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of the Company’s performance obligations under the arrangement, if any. The Company assesses whether a milestone is substantive at the inception of each arrangement.

License Fee Revenue

The Company defers recognition of non-refundable upfront license fees if it has continuing performance obligations, without which the licensed data, technology, or product has no utility to the licensee separate and independent of its performance under the other elements of the applicable arrangement. Non-refundable, up-front fees that are not contingent on any future performance by the Company and require no consequential continuing involvement on the Company’s part are recognized as revenue when the license term commences and the licensed data, technology or product is delivered. The specific methodology for the recognition of the revenue is determined on a case-by-case basis according to the facts and circumstances of the applicable agreement.

Product Sales Revenue

The Company’s product sales revenue is comprised of two components: sales of Vitaros^® product to its commercialization partners and sales of work-in-process inventory to its manufacturing partners. The Company has supply and manufacturing agreements with certain of its licensee partners for the manufacture and delivery of Vitaros^®product. These agreements do not permit the Company’s licensee partners to return product, unless the product sold to the licensee partner is delivered with a short-dated shelf life as specified in each respective license agreement, if applicable. In those cases, the Company defers revenue recognition until the right of return no longer exists, which is the earlier of: (i) evidence that the product has been sold to an end customer or (ii) the right of return has expired. As such, the Company does not have a sales and returns allowance recorded as of June 30, 2016 and December 31, 2015.

Historically, sales of component inventory to the manufacturing partners was accounted for on a net basis since these products were ultimately returned to the Company as finished goods and were then sold onto commercialization partners. As the majority of the Company’s commercialization partners are now buying the finished goods directly from the manufacturers, the Company’s component sales are no longer recognized on a net basis. During the three and six months ended June 30, 2016, the Company recognized $0.01 million and $0.3 million, respectively, in revenues from component sales to its third party manufacturers.

Royalty Revenue

The Company relies on its commercial partners to sell its Vitaros^® product in approved markets and receives royalty revenue from its commercial partners based upon the amount of those sales. Royalty revenues are computed and recognized on a quarterly basis, typically one quarter in arrears, and at the contractual royalty rate pursuant to the terms of each respective license agreement.

Cost of Goods Sold

The Company’s cost of goods sold includes direct material and manufacturing overhead associated with production. Cost of goods sold is also affected by manufacturing efficiencies, allowances for scrap or expired material and additional costs related to initial production quantities of new products. Cost of goods sold also includes the cost of one-time manufactured samples provided to the Company’s licensee partners free of charge.

Loss Per Common Share

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the same period. Diluted net loss per share is computed by dividing net loss by the weighted average number of common shares and common equivalent shares outstanding during the same period. Common equivalent shares may be related to stock options, restricted stock, warrants or shares related to convertible notes. The Company excludes common stock equivalents from the calculation of diluted net loss per share when the effect is anti-dilutive.

The following securities that could potentially decrease net loss per share in the future are not included in the determination of diluted loss per share as their effect is anti-dilutive:



	As of June 30,
	2016	2015
Outstanding stock options	4,924,921	4,474,736
Outstanding warrants	14,519,169	6,859,682
Restricted stock	1,155,759	—

Stock-Based Compensation

The Company estimates the fair value of each option award on the date of grant using the Black-Scholes option pricing model. The Company also issues performance-based shares which represent a right to receive a certain number of shares of common stock based on the achievement of corporate performance goals and continued employment during the vesting period. At each reporting period, the Company reassesses the probability of the achievement of such corporate performance goals and adjusts expense as necessary.

The following table presents the assumptions used by the Company to estimate the fair value of stock option grants using the Black-Scholes option-pricing model, as well as the resulting weighted average fair values:



	Six Months Ended June 30,
	2016			2015
Risk-free interest rate	1.36%-1.78%			1.39% - 1.69%
Volatility	72.35%-80.02%			81.13%-101.54%
Dividend yield	—		%	—		%
Expected term	5.25-6.08 years			5.25- 6.08 years
Forfeiture rate	11.33		%	11.54		%
Weighted average fair value	$	0.72		$	1.06

A summary of the Company’s stock option activity under its stock option plans during the six months ended June 30, 2016 is as follows (in thousands):



	Number of Shares		Weighted Average Exercise Price
Outstanding as of December 31, 2015	4,054		$	1.95
Granted	1,667		$	1.06
Exercised	—		$	—
Cancelled	(796	)	$	1.71
Outstanding as of June 30, 2016	4,925		$	1.68

A summary of the Company’s restricted stock unit activity under its stock option plans during the six months ended June 30, 2016 is as follows (in thousands):



	Number of Shares		Weighted Average Grant Date Fair Value
Unvested as of December 31, 2015	—		$	—
Granted	1,278		$	0.43
Vested	(122	)	$	0.30
Forfeited	—		$	—
Unvested as of June 30, 2016	1,156		$	0.44

During the second quarter of 2016, the Company granted approximately 1.0 million restricted stock units (“RSUs”) to its employees in order to retain and incentivize its employees to achieve its strategic objectives regarding Vitaros^®. One half of the RSUs will vest if the Company receives marketing approval of Vitaros^® in the United States by the Food and Drug Administration (“FDA”) on or before December 31, 2018 and the remaining half will vest on January 1, 2018. The RSUs are subject to the employee’s continued employment with the Company through the applicable date and subject to accelerated vesting upon a change in control of the Company. The RSUs granted to the Company’s officers are also subject to accelerated vesting pursuant to the terms of their existing employment agreements.

The following table summarizes the total stock-based compensation expense resulting from share-based awards recorded in the Company’s condensed consolidated statements of operations (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Research and development	$	362	$	57	$	425	$	87
General and administrative	377		268		669		526
Total	$	739	$	325	$	1,094	$	613

Segment Information

The Company operates under one segment which develops pharmaceutical products.

Recent Accounting Pronouncements

In May 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-12, Revenue from Contracts with Customers, the amendment of which addressed narrow-scope improvements to the guidance on collectability, noncash consideration, and completed contracts at transition as well as providing a practical expedient for contract modifications. In April 2016 and March 2016, the FASB issued ASU No. 2016-10 and ASU No. 2016-08, respectively, the amendments of which further clarified aspects of Topic 606: identifying performance obligations and the licensing and implementation guidance and intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The FASB issued the initial release of Topic 606 in ASU No. 2014-09, which requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Entities may use a full retrospective approach or report the cumulative effect as of the date of adoption. On July 9, 2015, the FASB voted to defer the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date. Early adoption of ASU 2016-10 is permitted but not before the original effective date (annual periods beginning after December 15, 2017). The Company is currently in the process of evaluating its various contracts and revenue streams subject to this update but has not completed its assessment and therefore has not yet concluded on whether the adoption of this update will have a material effect on its condensed consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The new standard simplifies income tax consequences and the classification of awards as either equity or liabilities and the classification on the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted for any organization in any interim or annual period. The Company is currently evaluating whether the adoption of the new standard will have a material effect on its condensed consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-2, Leases. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating whether the adoption of the new standard will have a material effect on its condensed consolidated financial statements and related disclosures.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company adopted this ASU on January 1, 2016 and this ASU had no material impact on the Company’s condensed consolidated financial statements and related disclosures. ASU 2015-03 requires a retroactive method of adoption, and therefore, the Company has reclassified approximately $0.07 million from other current assets to the current portion of its note payable as of December 31, 2015. Approximately $0.01 million and $0.02 million was reclassified from other expense to interest expense for the three and six months ended June 30, 2015, respectively.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments in this update will require management to assess, at each annual and interim reporting period, the entity’s ability to continue as a going concern and, if management identifies conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued, to disclose in the notes to the entity’s financial statements the principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern, management’s evaluation of their significance, and management’s plans that alleviated or are intended to alleviate substantial doubt about the entity’s ability to continue as a going concern. This new standard is effective for annual periods ending after December 15, 2016 and early adoption is permitted. The Company is currently in the process of evaluating whether the adoption of this update will have a material effect on its condensed consolidated financial statements and related disclosures.