Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated

financial statements of the Company have been prepared in accordance with US GAAP. Any reference in these notes to applicable guidance is meant to refer to US GAAP as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASU”) of the Financial Accounting Standards Board (“FASB”).

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires the Company 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, the Company evaluates its estimates using historical experience and other factors, including the current economic environment. Significant items subject to such estimates are assumptions used for purposes of determining stock-based compensation, the fair value of the warrants, the fair value of the convertible notes, allocation of the purchase price and accounting for research and development activities. Management believes its estimates to be reasonable under the circumstances. Actual results could differ significantly from those estimates.

Fair Value of Financial Instruments

The carrying amounts of the Company

’s financial instruments, including cash equivalents, accounts payable, and accrued expenses approximate fair value due to the short-term nature of those instruments. As of

December

31,

2017,

the fair value of the Company's outstanding Series B convertible note was approximately

$0.6

million. As of

December

31,

2016,

the fair value of the Company’s outstanding

2016

convertible note and Series B convertible note was approximately

$2.0

million and

$0.6

million, respectively. The fair value of the convertible notes is determined using a binomial lattice model that utilizes certain unobservable inputs that fall within Level

of the fair value hierarchy.

Concentration of Credit Risk

Financial instruments that potentially expose the Company to concentrations of credit risk consist principally of cash on deposit with multiple financial institutions, the balances of which frequently exceed federally insured limits.

Cash and Cash Equivalents

The Company considers any highly liquid investments, such as money market funds, with an original maturity of

three

months or less to be cash and cash equivalents.

Property and Equipment

The Company records property and equipment at cost less accumulated depreciation and amortization. Costs of renewals and improvements that extend the useful lives of the assets are capitalized. Maintenance and repairs are expensed as incurred. Depreciation is recognized on a straight-line basis over the estimated useful lives of the assets, which generally range from

years. The Company amortizes leasehold improvements over the shorter of the estimated useful life of the asset or the term of the related lease. Upon retirement or disposition of assets, the costs and related accumulated depreciation and amortization are removed from the accounts with the resulting gains or losses, if any, reflected in results of operations.

Long-Lived Assets

Long-lived assets are reviewed for potential impairment whenever events indicate that the carrying amount of such assets

may

not

be recoverable. The Company does this by comparing the carrying value of the long-lived assets with the estimated future undiscounted cash flows expected to result from the use of the assets, including cash flows from disposition. If it is determined an impairment exists, the asset is written down to its estimated fair value. The Company has

not

recognized any impairment of long-lived assets during the years ended

December 31, 2017

and

2016.

Intangible Assets

Intangible assets are comprised of identifiable in-process research and development (IPR&D) assets and are considered indefinite-lived intangible assets and are assessed for impairment annually on

October 1

or more frequently if impairment indicators exist. If the associated research and development effort is abandoned, the related assets will be written-off and the Company will record a non-cash impairment loss. For those compounds that reach commercialization, the IPR&D assets will be amortized over their estimated useful lives. In

August 2016,

the Company abandoned the future development efforts with respect to its RES-

440

product candidate, and the value of the associated IPR&D asset was written down to

zero

(See Note

Goodwill

Goodwill is the excess of the cost of an acquired entity over the net amounts assigned to tangible and intangible assets acquired and liabilities assumed. Goodwill is

not

amortized, but is subject to an annual impairment test. The Company has a single reporting unit and all goodwill relates to that reporting unit.

The Company performs its annual goodwill impairment test on

October 1

of each fiscal year or more frequently if changes in circumstances or the occurrence of events suggest that an impairment exists. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit

’s goodwill is less than the carrying value of the reporting unit’s goodwill. The Company did

not

recognize any impairment of goodwill during the years ended

December

31,

2017

and

December 31, 2016.

Offering Costs

Offering costs are either expensed upon completion or abandonment of the related financing or offset against the proceeds of the offering, depending upon the accounting treatment of the offering. Offering costs consist principally of legal and accounting costs incurred through the balance sheet date related to the Company’s underwritten public offering, private placement financings and are recognized in other assets on the consolidated balance sheet.

Research and Development

Major components of research and development costs include internal research and development (such as salaries and related employee benefits, equity-based compensation, supplies and allocated facility costs) and contracted services (research and development activities performed on the Company

’s behalf). Costs incurred for research and development are expensed as incurred.

At the end of the reporting period, the Company compares payments made to

third

-party service providers to the estimated progress toward completion of the research or development objectives. Such estimates are subject to change as additional information becomes available. Depending on the timing of payments to the service providers and the progress that the Company estimates has been made as a result of the services provided, the Company

may

record net prepaid or accrued expenses relating to these costs.

Upfront payments made to

third

parties who perform research and development services on the Company’s behalf are expensed as services are rendered.

Patent Costs

Patent costs, including related legal costs, are expensed as incurred and are recorded within general and administrative expenses in the statements of operations.

Income Taxes

Prior to the Merger, Diffusion LLC was treated as a partnership for federal and state income tax purposes. Diffusion LLC

’s taxable income or loss, as well as certain other tax attributes, were passed through directly to its members and were reported in each member’s individual income tax return.

Upon completion of the Merger as discussed in Note

the Company converted from a partnership to a corporation for accounting purposes. As a corporation, the Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided when it is more likely than

not

that some portion or all of a deferred tax asset will

not

be realized. The Company recognizes the benefit of an uncertain tax position that it has taken or expects to take on its income tax return it files, if such a position is more likely than

not

to be sustained.

December 22, 2017

the President of the United States signed into law the Tax Cuts and Jobs Act ("The

2017

Tax Act"). This legislation makes significant changes in the U.S. tax laws including, but

not

limited to, reducing the corporate tax rate to

21%

starting in

2018.

The

2017

Tax Act required the Company to revalue its deferred tax assets and liabilities to the new rate of

21%.

As a result of the change, the Company recorded a current period tax benefit of

$1.1

million in its consolidated statement of operations and a corresponding reduction in the deferred tax liability on its consolidated balance sheet.

Stock-based Compensation

The Company measures employee and nonemployee stock-based awards at grant-date fair value and records compensation expense on a straight-line basis over the vesting period of the award. Stock-based awards issued to non-employees are revalued until the award vests. The Company uses the Black-Scholes option pricing model to value its stock option awards. Estimating the fair value of stock option awards requires management to apply judgment and make estimates, including the volatility of the Company

’s common stock, the expected term of the Company’s stock options, the expected dividend yield and the fair value of the Company’s common stock on the measurement date. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards.

The expected term of stock options was estimated using the “simplified method” for employee options as the Company has

historical information to develop reasonable expectations about future exercise patterns and post vesting employment termination behavior for its stock option grants. The simplified method is based on the average of the vesting tranches and the contractual life of each grant. For options granted to non-employees, the Company uses the remaining contractual life. For stock price volatility, the Company uses comparable public companies as a basis for its expected volatility to calculate the fair value of option grants. The Company assumes

dividend yield because dividends are

not

expected to be paid in the near future, which is consistent with the Company

’s history of

not

paying dividends. The risk-free interest rate is based on U.S. Treasury notes with a term approximating the expected life of the option. The Company

longer estimates forfeitures and accounts for forfeitures in the periods they occur.

Net Loss Per Share

Basic loss per share is computed by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. For purposes of calculating diluted loss per common share, the denominator includes both the weighted average common shares outstanding and the number of common stock equivalents if the inclusion of such common stock equivalents would be dilutive. Dilutive common stock equivalents potentially include warrants, stock options and restricted stock awards using the treasury stock method and convertible debt using the “if-converted” method. The diluted loss per common share calculation is further affected by an add-back of change in fair value of warrant liability to the numerator under the assumption that the change in fair value of warrant liability would

not

have been incurred if the warrants had been converted into common stock.

	Year ended December 31,
	2017			2016
Basic net loss per common share calculation:
Net loss	$	(1,364,518	)	$	(18,036,619	)
Accretion of Series A cumulative preferred dividends		(1,252,394	)		—
Net loss attributable to common stockholders	$	(2,616,912	)	$	(18,036,619	)

Weighted average shares outstanding, basic		12,447,641			10,232,791
Net loss per share of common, basic	$	(0.21	)	$	(1.76	)
Diluted net loss per common share calculation:
Net loss attributable to common stockholders		(2,616,912	)		(18,036,619	)
Change in fair value of warrant liability		(22,072,322	)		—
Diluted net loss		(24,689,234	)		(18,036,619	)
Weighted average common shares outstanding, basic		12,447,641			10,232,791
Common stock equivalents arising from warrants		307,675			—
Common stock equivalents		12,755,316			10,232,791
Net loss per share of common stock, diluted	$	(1.94	)	$	(1.76	)

The following potentially dilutive securities outstanding have been excluded from the computation of diluted weighted average shares outstanding, as they would be anti-dilutive:

	December 31,
	2017		2016
Convertible debt		214,385		757,909
Common stock warrants		447,721		460,721
Convertible preferred stock		8,306,278		—
Stock options		2,555,989		2,207,409
Unvested restricted stock awards		3,066		9,204
		11,527,439		3,435,243

Amounts in the table reflect the common stock equivalents of the noted instruments.

Comprehensive Loss

The Company has

items of comprehensive income or loss other than net loss.

Recent Accounting Pronouncements

July 2017,

the FASB issued ASU

2017

11,

Earnings Per Share (Topic

260

); Distinguishing Liabilities from Equity (Topic

480

); Derivatives and Hedging (Topic

815

): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.

The

first

part of this update addresses the complexity of accounting for certain financial instruments with down round features and the

second

part addresses the complexity of distinguishing liabilities from equity. The guidance is applicable to public business entities for fiscal years beginning after

December 15, 2018

and interim periods within those years. The Company is currently evaluating the potential impact of the adoption of this standard on its consolidated results of operations, financial position and cash flows and related disclosures.

May 2017,

the FASB issued ASU

No.

2017

09,

Modification Accounting for Share-Based Payment Arrangements

, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC

718.

Specifically, an entity would

not

apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The guidance is applicable to public business entities for fiscal years beginning after

December 15, 2017

and interim periods within those years. Early adoption is permitted, including adoption in any interim period. The Company does

not

expect this new guidance to have a material impact on its consolidated financial statements.

March

2016,

the FASB issued ASU

2016

09,

Compensation – Improvements to Employee Share-Based Payment Accounting

, which simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance is applicable to public business entities for fiscal years beginning after

December 15, 2016

and interim periods within those years. The Company adopted this standard in

2017

by electing to account for forfeitures in the period that they occur. Under ASU

2016

09,

accounting changes adopted using the modified retrospective method must be calculated as of the beginning of the period adopted and reported as a cumulative-effect adjustment. As a result, the Company recognized cumulative-effect adjustment of approximately

$1,000

January 1, 2017.

February 2016,

the FASB issued ASU

2016

02,

Leases (Topic

842

)

. The FASB issued the update to require the recognition of lease assets and liabilities on the balance sheet of lessees. The standard will be effective for fiscal years beginning after

December

15,

2018,

including interim periods within such fiscal years. The ASU requires a modified retrospective transition method with the option to elect a package of practical expedients. Early adoption is permitted. Upon adoption in

2018,

the Company will determine the fair of the operating lease and recognize this amount as a lease asset and corresponding liability on its consolidated balance sheet. The Company does

not

expect this new guidance to have a material impact on its consolidated financial statements.