Note 9 - Debentures

6 Months Ended

Jun. 30, 2023

Notes to Financial Statements

Debt Disclosure [Text Block]

NOTE 9. CONVERTIBLE NOTE

On April 27, 2023, the Company entered into a Securities Purchase Agreement with existing accredited institutional investors (the “Purchasers”) of the Company that provided for the issuance and sale in a private placement (the “2023 Private Placement”) of (i) $3.3 million aggregate principal amount  (the “Aggregate Principal Amount”) of Original Issue Discount Senior Secured Convertible Debentures Due November 1, 2024 (the “Convertible Notes”) that may be converted or redeemed into up to an aggregate of 2,538,464 shares of common stock (the “Conversion Shares”),  (ii) a new long-term Series B-1 warrant exercisable for up to an aggregate of 2,538,464 shares of common stock through June 9, 2028 (“Series B-1 Warrants”), and (iii) a new short-term Series B-2 warrant exercisable for up to an aggregate of 2,538,464 shares of common stock through June 9, 2025 (“Series B-2 Warrants” and, together with the Series B-1 Warrants, the “May 2023 Warrants”). The May 2023 Warrants have an exercise price of $1.30 per share. The 2023 Private Placement closed on May 1, 2023 and the Company received gross proceeds of $3.0 million, before deducting placement agent fees and other offering expenses. Ladenburg served as the Company’s exclusive placement agent in the 2023 Private Placement and received a fee equal to 8% of the total gross proceeds and were reimbursed for certain related expenses.

Due to the number of shares of common stock that may be issued upon conversion or redemption of the Convertible Notes and the exercise of the May 2023 Warrants, the Company was required to obtain stockholder approval for the issuance of these shares of common stock in accordance with Section 713(a) and 713(b) of the NYSE American Company Guide (the “Stockholder Approval”). The Company received Stockholder Approval at its 2023 Annual Meeting of Stockholders on June 9, 2023, and, as a result, the Convertible Notes and the May 2023 Warrants are currently convertible or exercisable, as applicable, in accordance with their respective terms.

The Convertible Notes are convertible by the holder, in whole or in part, into shares of common stock at a conversion price equal to $1.30 per share (“Conversion Price”) at any time, subject to certain limitations upon conversion. The Convertible Notes are subject to a limitation upon conversion into shares of Common Stock to the extent that, after giving effect to such conversion, the holder of a Convertible Note (together with the holder’s affiliates, and any other persons acting as a group together with the holder or any of the holder’s affiliates), would beneficially own in excess of 4.99% or 9.99% of the outstanding Common Stock. The Company is required to make a monthly redemption of the Convertible Notes (“Monthly Redemption”) beginning on June 1, 2023 equal to 1/18^th of the Aggregate Principal Amount multiplied by 1.10 in cash; or, as provided in the Convertible Notes, in shares of common stock at the election of the Company under certain conditions as defined in the agreement with a conversion rate equal to the lower of (i) the Conversion Price or (ii) 90% of the Company’s average volume-weighted average price over 10 trading days. At the election of the holders, the Convertible Notes also provide for a mandatory redemption by the Company of a portion of the principal amount of the Convertible Notes after completing a subsequent financing. The redemption amount of the Convertible Notes shall be equal to at least 20% of the gross proceeds received by the Company in such subsequent financing.

If any event of default occurs, the outstanding principal amount of the Convertible Notes, plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the holder’s election, immediately due and payable in cash. Commencing five days after the occurrence of any event of default that results in the eventual acceleration of the Convertible Notes, the interest rate on the Convertible Notes shall accrue at an interest rate equal to the lesser of 18% per annum and the maximum rate permitted under applicable law. The Convertible Notes are secured obligations of the Company and DERMAdoctor pursuant to the terms of the Security Agreement, dated April 27, 2023 (the “Security Agreement”). Under the terms of the Security Agreement, the holders of the Convertible Notes were granted a security interest, a lien upon and a right of set-off against all of the Company’s and DERMAdoctor’s assets as collateral security for the complete, timely payment, performance and discharge of the obligations under the Convertible Notes. To further secure the Company’s obligations under the Convertible Notes, DERMAdoctor also executed a Subsidiary Guarantee (the “Subsidiary Guarantee”), pursuant to which DERMAdoctor is a guarantor of the Company’s obligations owed to the Convertible Notes holders. 

The lender’s conversion and subsequent financing redemption option and certain events of default represent embedded call options. The Company’s monthly share redemption option represents an embedded put option. Each of the options requires bifurcation.

The Company allocated the proceeds from the 2023 Private Placement between the May 2023 Warrants, combined embedded derivative liabilities, and the Convertible Notes by applying the residual fair value methodology. The Company first allocated $1.6 million to the May 2023 Warrants and $0.2 million to the derivative liabilities with the residual $1.2 million to the Convertible Notes.

A single derivative comprising all bifurcatable features was measured at fair value using the Black Scholes valuation model. The weighted average key assumptions based on probability of occurrence used to value the combined embedded derivative upon issuance were as follows:

Stock price	$	0.72
Equity volatility		80.1	%
Risk-free interest rate		4.88	%
Dividend yield		0.0	%
Remaining term		0.8

The fair value of the combined embedded derivative was $209 thousand as of April 27, 2023.

The key assumptions used to value the combined embedded derivative as of June 30, 2023 were as follows:

Assumption	As of June 30, 2023
Stock price	$	0.75
Equity volatility		76.9	%
Risk-free interest rate		5.41	%
Remaining term	0.7

The fair value of the combined embedded derivative was $169 thousand as of June 30, 2023. The change of $40 thousand in fair value between the date of issuance and June 30, 2023 was recorded as a non-cash gain in the consolidated statements of operations and comprehensive loss.

The aggregate $300 thousand original issue discount, and the $294 thousand of debt issuance costs that were allocated to the Convertible Notes based on the relative fair value method, were recorded at issuance as an offset to the Convertible Notes on the Company’s unaudited condensed consolidated balance sheet. The Convertible Notes are presented as follows as of June 30, 2023:

(in thousands)
Principal amount	$	3,117
Unamortized discount		(1,696	)
Unamortized debt issuance costs		(236	)
Total Convertible Note, net		1,185

The Convertible Notes, net is classified as short term in the Company’s unaudited condensed consolidated balance sheet.

The discount and debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Convertible Notes, assuming that the Convertible Notes will be redeemed for cash of $193 thousand per month beginning in June 2023. During both the three and six months ended June 30, 2023, the effective interest rate on the Convertible Notes was 173%. Interest expense recognized, including amortization of the issuance costs and debt discount, was $501 thousand during the three and six months ended June 30, 2023.

As of June 30, 2023, the Company's contractual maturity of the principal balance of the Convertible Notes was as follows:

(in thousands)
Remainder of 2023	$	1,100
2024		2,017
Total	$	3,117