CervoMed Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Description Page Report of Independent Registered Public Accounting Firm 47 Consolidated Balance Sheets as of December 31, 2020 and 2019 48 Consolidated Statements of Operations for the years ended December 31, 2020 and 2019 49 Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2020 and 2019 50 Consolidated Statements of Cash Flows for the years ended December 31, 2020 and 2019 51 Notes to the Consolidated Financial Statements for the years ended December 31, 2020 and 2019 52 46 Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Diffusion Pharmaceuticals Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Diffusion Pharmaceuticals Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years then ended, in conformity with U.S. generally accepted accounting principles. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Deemed dividend As discussed in Note 7 to the consolidated financial statements, the Company entered into a warrant exercise agreement with an investor who held a previously outstanding warrant. The Company recognized a deemed dividend of $2.0 million to reflect the fair value of the consideration given as an inducement for the investor to exercise the warrants. We identified the evaluation of the deemed dividend as a critical audit matter. A higher degree of auditor judgment was required to evaluate the application of the accounting guidance due to the unique nature of the transaction with the investor. The following are the procedures we performed to address this critical audit matter. We read and evaluated the Company’s accounting memorandum that documented the business purpose, the terms of the agreements underlying the transaction, and the factors the Company considered in determining the applicable accounting treatment. We compared the facts and circumstances in the Company’s accounting memorandum to the agreements underlying the transaction. /s/ KPMG LLP We have served as the Company’s auditor since 2015. McLean, Virginia March 16, 2021 47 DIFFUSION PHARMACEUTICALS INC. CONSOLIDATED BALANCE SHEETS December 31, 2020 2019 Assets Current assets: Cash and cash equivalents $ 18,515,595 $ 14,177,349 Prepaid expenses, deposits and other current assets 260,825 472,464 Total current assets 18,776,420 14,649,813 Property and equipment, net 149,198 252,366 Intangible asset 8,639,000 8,639,000 Right of use asset 149,162 247,043 Other assets 15,771 322,301 Total assets $ 27,729,551 $ 24,110,523 Liabilities and Stockholders ’ Equity Current liabilities: Accounts payable $ 545,844 $ 1,251,412 Accrued expenses and other current liabilities 1,776,470 358,532 Current operating lease liability 113,469 111,477 Total current liabilities 2,435,783 1,721,421 Deferred income taxes 443,893 2,119,274 Noncurrent operating lease liability 35,693 135,566 Total liabilities 2,915,369 3,976,261 Commitments and Contingencies (Note 6) Stockholders’ Equity: Common stock, $0.001 par value: 1,000,000,000 shares authorized; 64,015,441 and 33,480,365 shares issued and outstanding at December 31, 2020 and 2019, respectively 64,016 33,481 Additional paid-in capital 130,659,550 111,824,859 Accumulated deficit (105,909,384 ) (91,724,078 ) Total stockholders' equity 24,814,182 20,134,262 Total liabilities and stockholders' equity $ 27,729,551 $ 24,110,523 See accompanying notes to consolidated financial statements. 48 DIFFUSION PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2020 2019 Operating expenses: Research and development $ 9,427,667 $ 6,619,597 General and administrative 6,444,109 4,834,284 Depreciation 103,168 97,915 Loss from operations (15,974,944 ) (11,551,796 ) Other income: Interest income 114,257 85,302 Loss from operations before income taxes (15,860,687 ) (11,466,494 ) Income tax benefit (expense) 1,675,381 (332,885 ) Net loss $ (14,185,306 ) $ (11,799,379 ) Deemed dividend arising from warrant exchange (1,950,378 ) — Net loss attributable to common stockholders $ (16,135,684 ) $ (11,799,379 ) Share information: Net loss per share of common stock, basic and diluted $ (0.30 ) $ (1.76 ) Weighted average shares outstanding, basic and diluted 53,831,973 6,706,509 See accompanying notes to consolidated financial statements. 49 DIFFUSION PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS ’ EQUITY Stockholders' Equity Common Stock Additional Paid-in Accumulated Total Stockholders' Shares Amount Capital Deficit Equity Balance at December 31, 2018 3,376,230 $ 3,377 $ 95,532,881 $ (79,924,699 ) $ 15,611,559 Issuance of common stock, pre-funded warrants and warrants, net of issuance costs 12,688,276 12,688 11,905,207 — 11,917,895 Issuance of common stock upon exercise of warrants 17,415,859 17,416 3,871,009 — 3,888,425 Stock-based compensation expense — — 515,762 — 515,762 Net loss — — — (11,799,379 ) (11,799,379 ) Balance at December 31, 2019 33,480,365 33,481 111,824,859 (91,724,078 ) 20,134,262 Issuance of common stock and warrants, net of issuance costs 11,428,572 11,429 10,330,202 — 10,341,631 Issuance of common stock upon exercise of warrants 19,106,504 19,106 7,768,370 — 7,787,476 Stock-based compensation expense — — 736,119 — 736,119 Net loss — — — (14,185,306 ) (14,185,306 ) Balance at December 31, 2020 64,015,441 $ 64,016 $ 130,659,550 $ (105,909,384 ) $ 24,814,182 See accompanying notes to consolidated financial statements. 50 DIFFUSION PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2020 2019 Operating activities: Net loss $ (14,185,306 ) $ (11,799,379 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 103,168 97,915 Stock-based compensation expense 736,119 515,762 Change in deferred income taxes (1,675,381 ) 332,885 Changes in operating assets and liabilities: Prepaid expenses, deposits and other assets 518,169 426,774 Accounts payable, accrued expenses and other liabilities 950,602 567,668 Net cash used in operating activities (13,552,629 ) (9,858,375 ) Cash flows provided by financing activities: Proceeds from the sale of common stock 10,827,100 — Proceeds from the sale of common stock, pre-funded warrants and warrants — 12,318,956 Proceeds from the exercise of common stock warrants and pre-funded warrants 8,046,103 3,888,425 Payment of offering costs (982,328 ) (162,829 ) Net cash provided by financing activities 17,890,875 16,044,552 Net increase in cash and cash equivalents 4,338,247 6,186,177 Cash and cash equivalents at beginning of year 14,177,349 7,991,172 Cash and cash equivalents at end of year $ 18,515,595 $ 14,177,349 Supplemental disclosure of non-cash investing and financing activities: Offering costs in accounts payable and accrued expenses $ — $ 238,232 Operating lease right of use asset and liability $ — $ 334,205 See accompanying notes to consolidated financial statements. 51 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business Diffusion Pharmaceuticals Inc., a Delaware corporation, an innovative biopharmaceutical company developing novel therapies that enhance the body’s ability to deliver oxygen to the areas where it is needed most. The Company’s lead product candidate, TSC, is being developed to enhance the diffusion of oxygen to tissues with low oxygen levels, also known as hypoxia, a serious complication of many of medicine’s most intractable and difficult-to-treat conditions. In addition to TSC, the Company's product candidate DFN-529, a novel, allosteric PI3K/Akt/mTOR pathway inhibitor, is in early-stage development. The Company previously completed two Phase 1 clinical trials evaluating DFN-529 in age-related macular degeneration. DFN-529 was also previously in preclinical development in oncology, specifically GBM. 2. Liquidity The Company has not generated any revenues from product sales and has funded operations primarily from the proceeds of public and private offerings of equity, convertible debt and convertible preferred stock. Substantial additional financing will be required by the Company to continue to fund its research and development activities. No assurance can be given that any such financing will be available when needed, or at all, or that the Company’s research and development efforts will be successful. The Company regularly explores alternative means of financing its operations and seeks funding through various sources, including public and private securities offerings, collaborative arrangements with third parties and other strategic alliances and business transactions. The Company does not have any commitments to obtain additional funds and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If the Company cannot obtain the necessary funding, it will need to delay, scale back or eliminate some or all of its research and development programs or enter into collaborations with third parties to commercialize potential products or technologies that it might otherwise seek to develop or commercialize independently; consider other various strategic alternatives, including a merger or sale of the Company; or cease operations. If the Company engages in collaborations, it may receive lower consideration upon commercialization of such products than if it had not entered such arrangements or if it entered into such arrangements at later stages in the product development process. Operations of the Company are subject to certain risks and uncertainties including various internal and external factors that will affect whether and when the Company’s product candidates become approved drugs and how significant their market share will be, some of which are outside of the Company’s control. The length of time and cost of developing and commercializing these product candidates and/or failure of them at any stage of the drug approval process will materially affect the Company’s financial condition and future operations. The Company expects that its existing cash and cash equivalents as of December 31, 2020, combined with the proceeds received by the Company in connection with the completion of the February 2021 Offering and the exercise of certain warrants to purchase common stock during the first quarter of 2021 prior to the date of this Annual Report, will enable it to fund its operating expenses and capital expenditure requirements, including expected costs related to the planned TSC Oxygenation Trials and the Planned Phase 2 Hypoxia-related Indication Trial through 2023. 3. 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 GAAP. Any reference in these notes to applicable guidance is meant to refer to GAAP as found in the Accounting Standards Codification and Accounting Standards Updates of the Financial Accounting Standards Board. Use of Estimates The preparation of financial statements in conformity with 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 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. 52 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value of Financial Instruments The carrying amounts of the Company’s financial instruments, including cash equivalents and accounts payable approximate fair value due to the short-term nature of those instruments. 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 2 to 15 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, 2020 and 2019. Intangible Asset The Company has an indefinite-lived IPR&D asset, DFN-529, which has a balance of $8.6 million at both December 31, 2020 and December 31, 2019. DFN-529 is a PI3K/Akt/mTOR pathway inhibitor in preclinical development for oncology. Intangible assets deemed to have indefinite lives are not amortized but rather are assessed for impairment annually on October 1 of the Company’s fiscal year or more frequently if impairment indicators exist. There was no impairment to the Company’s DFN-529 intangible asset recognized during the years ended December 31, 2020 and 2019. 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. 53 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Patent Costs Patent costs, including related legal costs, are expensed as incurred and are recorded within general and administrative expenses in the consolidated statements of operations. Income Taxes 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. ASC 740-10 defines the criterion an individual tax position must meet for any part of the benefit of the tax position to be recognized in financial statements prepared in conformity with GAAP. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not such tax position will be sustained on examination by the taxing authorities, based solely on the technical merits of the respective tax position. The tax benefits recognized in the financial statements from such a tax position should be measured based on the largest benefit having a greater than 50.0% likelihood of being realized upon ultimate settlement with the tax authority. In accordance with the disclosure requirements of ASC 740-10, the Company’s policy on income statement classification of interest and penalties related to income tax obligations is to include such items as part of total interest expense and other expense, respectively. Stock-based Compensation The Company measures stock-based awards at grant-date fair value and records compensation expense on a straight-line basis over the vesting period of the award. The Company uses the Black-Scholes 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. For certain stock option grants, the expected term was estimated using the “simplified method” for employee options as the Company has limited 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. During the year ended December 31, 2020, it became apparent that the expected term of the Company's stock options was commensurate with the contractual life (i.e. 10 years) of the stock option and therefore the Company began to use the contractual life as the expected term. For stock price volatility, the Company uses a combination of their own historical stock price and comparable public companies as a basis for its expected volatility to calculate the fair value of option grants. The Company assumes no 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 accounts for forfeitures in the periods they occur. Net Loss Per Common Share Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted net loss per share includes the effect, if any, from the potential exercise or conversion of securities, such as convertible debt, convertible preferred stock, common stock warrants, stock options and unvested restricted stock that would result in the issuance of incremental shares of common stock. In computing the basic and diluted net loss per share applicable to common stockholders, the weighted average number of shares remains the same for both calculations due to the fact that when a net loss exists, dilutive shares are not included in the calculation as the impact is anti-dilutive. 54 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2020 2019 Common stock warrants 9,100,112 22,385,141 Stock options 2,240,204 309,276 11,340,316 22,694,417 Recently Issued But Not Yet Adopted Accounting Pronouncements In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes . This guidance applies to all entities and aims to reduce the complexity of tax accounting standards while enhancing reporting disclosures. This guidance is effective for fiscal years beginning after December 15, 2020 and interim periods therein. Early adoption is permitted for any annual periods for which financial statements have not been issued and interim periods therein. The Company is currently analyzing the impact of ASU No. 2019-12 on the consolidated financial statements. Recently Adopted Accounting Pronouncements In August 2018, the FASB issued ASU 2018-03, Disclosure Framework- Changes to the Disclosure Requirements for Fair Value Measurements, which changes the fair value measurement disclosure requirements of ASC 820. The goal of the ASU is to improve the effectiveness of ASC 820's disclosure requirements. The Company adopted this standard in January 2020 and the adoption did not have a material impact on its related disclosures. 4. Property and Equipment Property and equipment consists of the following: December 31, 2020 2019 Laboratory equipment $ 182,357 $ 182,357 Furniture and office equipment 151,442 151,442 Leasehold improvements 430,000 430,000 Total property and equipment 763,799 763,799 Less: accumulated depreciation and amortization (614,601 ) (511,433 ) Property and equipment, net $ 149,198 $ 252,366 Depreciation and amortization expense was approximately $0.1 million for both the years ended December 31, 2020 and 2019. 5. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consist of the following: December 31, 2020 2019 Accrued payroll and payroll related expenses $ 653,899 $ 182,708 Accrued professional fees 31,809 48,338 Accrued clinical studies expenses 1,055,398 57,378 Other 35,364 70,108 Total $ 1,776,470 $ 358,532 55 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. Commitments and Contingencies Office Space Lease Commitment The Company has a non-cancelable operating lease for office and laboratory space in Charlottesville, Virginia, which began in April 2017 and, as of December 31, 2020, has a remaining lease term of approximately 1.3 years. The discount rate used to account for the Company's operating lease is the Company’s estimated incremental borrowing rate of 10.0%. The original term of the lease ends in the second quarter of 2022 and the Company has an option to extend for another 5 years. This option to extend was not recognized as part of the Company's measurement of the right-of-use asset and operating lease liability as of December 31, 2020. Rent expense related to the Company's operating lease for both the years ended December 31, 2020 and 2019 was approximately $0.1 million. Future minimum rental payments under the Company's non-cancelable operating lease at December 31, 2020 were as follows: Rental Commitments 2021 $ 118,519 2022 39,735 Total 158,254 Less: imputed interest (9,092 ) $ 149,162 Research and Development Arrangements In the course of normal business operations, the Company enters into agreements with universities and contract research organizations, or CROs, to assist in the performance of research and development activities and contract manufacturers to assist with chemistry, manufacturing, and controls related expenses. Expenditures to CROs represent a significant cost in clinical development for the Company. The Company could also enter into additional collaborative research, contract research, manufacturing, and supplier agreements in the future, which may require upfront payments and long-term commitments of cash. Defined Contribution Retirement Plan The Company has established its 401(k) Plan, which covers all employees who qualify under the terms of the plan. Eligible employees may elect to contribute to the 401(k) Plan up to 90.00% of their compensation, limited by the IRS-imposed maximum. The Company provides a safe harbor match with a maximum amount of 4.0% of the participant’s compensation. The Company made matching contributions under the 401(k) Plan of approximately $56,000 and $68,000 for the years ended December 31, 2020 and 2019, respectively. 56 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Legal Proceedings On August 7, 2014, a complaint was filed in the Superior Court of Los Angeles County, California by Paul Feller, the former Chief Executive Officer of the Company's legal predecessor under the caption Paul Feller v. RestorGenex Corporation, Pro Sports & Entertainment, Inc., ProElite, Inc. and Stratus Media Group, GmbH (Case No. BC553996). The complaint asserts various causes of action, including, among other things, promissory fraud, negligent misrepresentation, breach of contract, breach of employment agreement, breach of the covenant of good faith and fair dealing, violations of the California Labor Code and common counts. The plaintiff is seeking, among other things, compensatory damages in an undetermined amount, punitive damages, accrued interest and an award of attorneys’ fees and costs. On December 30, 2014, the Company filed a petition to compel arbitration and a motion to stay the action. On April 1, 2015, the plaintiff filed a petition in opposition to the Company’s petition to compel arbitration and a motion to stay the action. After a hearing for the petition and motion on April 14, 2015, the Court granted the Company’s petition to compel arbitration and a motion to stay the action. On January 8, 2016, the plaintiff filed an arbitration demand with the American Arbitration Association. On November 19, 2018 at an Order to Show Cause Re Dismissal Hearing, the Court found sufficient grounds not to dismiss the case, and an arbitration hearing was scheduled for November 2020. In August 2020, due to the ongoing COVID-19 pandemic and related restrictions on gatherings in the State of California, the arbitration hearing was postponed to August 16, 2021. The Company believes this matter is without merit and intends to defend the arbitration vigorously. However, at this stage, the Company is unable to predict its outcome and the possible loss or range of loss, if any, associated with its resolution or any potential effect the matter may have on the Company’s financial position. Depending on the outcome or resolution of this matter, it could have a material effect on the Company’s financial position. 7. Stockholders' Equity and Common Stock Warrants 2020 Common Stock Offering In May 2020, the Company completed the May 2020 Offering, a public offering of 11,428,572 shares of common stock for a purchase price of $1.05 per share for net proceeds of $10.3 million after deducting commissions, discounts, and other offering costs. In addition, at the closing of the May 2020 Offering, the Company issued warrants to purchase up to 571,429 shares of common stock to designees of the placement agent for the May 2020 Offering. The placement agent's warrants have an exercise price of $1.3125 per share and a term of five years from the date of issuance. Additionally, also in May 2020, the Company entered into a warrant exercise agreement with an investor who held a previously outstanding warrant to purchase up to an aggregate of 5,000,000 shares of our common stock at an exercise price of $0.35 per share(the Prior Warrant). In consideration for the exercise of the Prior Warrant for cash and an additional $0.125 per each share of common stock resulting from the exercise, the exercising investor received new unregistered warrants to purchase up to an aggregate of 5,000,000 shares of common stock in a private placement. The warrants are exercisable immediately at an exercise price of $0.5263 per share and exercisable until November 8, 2025. The Company recognized a deemed dividend of $2.0 million to reflect the consideration given as an inducement for the investor to exercise the warrants. This deemed dividend is recorded in the Company's consolidated statement of operations during the year ended December 31, 2020 as an increase to the net loss attributable to common stockholders for purposes of computing net loss per share, basic and diluted. In connection with the warrants exercised in May 2020, the Company issued warrants to purchase up to 250,000 shares of common stock to the placement agent with an exercise price of $0.5938 per share and otherwise have identical terms to the warrants issued to the investor. 2019 Common Stock Offerings In December 2019, Company completed the December 2019 Offering, an offering of 6,266,787 shares of its common stock and warrants to purchase 6,266,787 shares of common stock. The shares of common stock and warrants were sold for a combined purchase price of $0.5585 per share for net proceeds of $3.0 million. The December 2019 Offering warrants are exercisable beginning on the date of their issuance until June 13, 2025 at an initial exercise price equal to $0.4335 per share. In addition, at the closing of the December 2019 Offering, the Company issued warrants to purchase up to 313,339 shares of common stock to designees of the placement agent. The placement agent's warrants have an exercise price of $0.6981 per share and a term of five years from the date of issuance. 57 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In November 2019, the Company completed the November 2019 Offering, a registered direct public offering of 5,104,429 shares of its common stock, and 6,324,143 pre-funded warrants each to purchase one share of common stock, together with warrants to purchase up to 22,857,144 shares of common stock at a combined public offering price of $0.35 per share and associated warrants for total net proceeds of $3.3 million. The warrants were issued with an exercise price of $0.35 per warrant and are exercisable beginning on their date of issuance. Of the warrants issued, 11,428,572 have a term of 18 months and 11,428,572 have a term of 5 years. During the year ended December 31, 2019, 11,091,716 of those warrants were exercised for additional proceeds of $3.9 million. In addition, at the closing of the November 2019 Offering, the Company issued warrants to purchase up to 571,429 shares of common stock to designees of the placement agent. The placement agent's warrants have an exercise price of $0.4375 per share and a term of five years from the date of issuance. In May 2019, the Company completed the May 2019 Offering, a registered direct public offering of 1,317,060 shares of common stock and a private placement of warrants to purchase 1,317,060 shares of common stock. The shares of common stock and warrants were sold for a combined purchase price of $4.895 for total net proceeds of $5.6 million. The warrants are exercisable beginning on the date of their issuance until November 29, 2024 at an initial exercise price equal to $5.00. In addition, at the closing of the May 2019 Offering, the Company issued warrants to purchase up to 65,853 shares of common stock to designees of the placement agent. The placement agent's warrants have an exercise price of $6.11875 per share, a term of 5 years from the date of issuance and otherwise substantially similar terms to the form of the investor warrant. Common Stock Warrants During its evaluation of equity classification for the Company's common stock warrants issued in 2020 and 2019, the Company considered the conditions as prescribed within ASC 815-40, Derivatives and Hedging, Contracts in an Entity ’ s own Equity . The conditions within ASC 815-40 are not subject to a probability assessment. The warrants do not fall under the liability criteria within ASC 480, Distinguishing Liabilities from Equity as they are not puttable and do not represent an instrument that has a redeemable underlying security. The warrants do meet the definition of a derivative instrument under ASC 815, but are eligible for the scope exception as they are indexed to the Company’s own stock and would be classified in permanent equity if freestanding. As of December 31, 2020, the Company had the following warrants outstanding to acquire shares of its common stock: Outstanding Range of exercise price per share Expiration dates Common stock warrants issued in 2017 related to Series A convertible preferred stock offering 903,870 $33.30 March 2022 Common stock warrants issued in 2018 related to the January 2018 common stock offering 1,181,421 $12.00 - $15.00 January 2023 Common stock warrants issued related to the May 2019 Offering 1,382,913 $5.00 - $6.11875 May and December 2024 Common stock warrants issued related to the November 2019 Offering 497,140 $0.35 - $0.4375 May 2024 Common stock warrants issued related to the December 2019 Offering 313,339 $0.4335 - $0.6981 December 2024 and June 2025 Common stock warrants issued related to the May 2020 Offering 571,429 $1.31 March 2025 Common stock warrants issued related to the May 2020 Investor Warrant Exercise 4,250,000 $0.5263 - $0.5938 November 2025 9,100,112 During the year ended December 31, 2020, no warrants expired and 19,106,504 warrants were exercised for gross proceeds of $8.0 million. During the year ended December 31, 2019, 1,767 warrants expired and 17,415,859 warrants were exercised for net proceeds of $3.9 million. 58 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. Stock-Based Compensation 2015 Equity Plan The 2015 Equity Plan provides for increases to the number of shares reserved for issuance thereunder each January 1 equal to 4.0% of the total shares of the Company’s common stock outstanding as of the immediately preceding December 31, unless a lesser amount is stipulated by the Compensation Committee of the Company's board of directors. Accordingly, 2,560,618 shares were added to the reserve as of January 1, 2021, which shares may be issued in connection with the grant of stock-based awards, including stock options, restricted stock, restricted stock units, stock appreciation rights and other types of awards as deemed appropriate, in each case, in accordance with the terms of the 2015 Equity Plan. As of December 31, 2020, there were no shares of common stock available for future issuance under the 2015 Equity Plan. Further, the Company granted options to purchase 270,000 shares of common stock to employees during the year ended December 31, 2020 that were granted outside of the 2015 Equity Plan as an inducement material to the employee’s acceptance of employment with the Company in accordance with Nasdaq Listing Rule 5635(c)(4). Generally, the options have a ten (10) year contractual term and vest in equal monthly installments over three (3) years. The Company recorded stock-based compensation expense in the following expense categories of its consolidated statements of operations for the periods indicated: Year ended December 31, 2020 2019 Research and development $ 164,791 $ 54,155 General and administrative 571,328 461,607 Total stock-based compensation expense $ 736,119 $ 515,762 The following table summarizes the activity related to all stock option: Number of Options Weighted average exercise price per share Weighted average remaining contractual life (in years) Aggregate Intrinsic Value Balance at January 1, 2019 203,736 $ 88.14 Granted 117,270 2.62 Forfeited (11,583 ) 83.81 Expired (147 ) 276.00 Balance at December 31, 2019 309,276 $ 55.78 6.98 — Granted 1,931,100 0.68 Expired (172 ) 142.50 Outstanding at December 31, 2020 2,240,204 $ 8.28 8.90 $ 289,067 Exercisable at December 31, 2020 1,129,733 $ 15.64 8.28 $ 219,010 Vested and expected to vest at December 31, 2020 2,240,204 $ 8.28 8.90 $ 289,067 The weighted average grant date fair value of stock option awards granted was $0.64 and $2.16 during the years ended December 31, 2020 and 2019, respectively. The total fair value of options vested during the years ended December 31, 2020 and 2019 were $0.7 million and $0.6 million, respectively. No options were exercised during any of the periods presented. At December 31, 2020, there was $0.8 million of unrecognized compensation cost related to unvested options that will be recognized as expense over a weighted-average period of 2.2 years. 59 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The grant date fair value of employee stock options is determined using the Black-Scholes Model. The following assumptions were used during the years ended December 31, 2020 and 2019: 2020 2019 Expected term (in years) 5.31 — 10.00 5.25 — 5.77 Risk-free interest rate 0.4% — 1.7% 1.9% — 2.5% Expected volatility 113.4% — 124.8% 112.4% — 114.4% Dividend yield — — — — — — Restricted Stock Unit Awards During the year ended December 31, 2020, the Company granted 153,000 restricted stock units to members of the board of directors of the Company. The weighted average grant date fair value of the restricted stock units granted during the year ended December 31, 2020 was $0.65. The shares begin to vest 18 months after the grant date. The Company recognized approximately $18,000 in expense related to these units during the year ended December 31, 2020. At December 31, 2020, there was approximately $82,000 of unrecognized compensation cost that will be recognized over a weighted average period of 2.4 years. 9. Income Taxes Since inception, the Company has incurred net losses, and until 2018, had not recorded any U.S. federal or state income tax benefits for the losses. In 2018, as a result of the change in net operating loss carryforward period associated with the 2017 Tax Act, the Company recognized an income tax benefit to reflect the adjustment allowed by the 2017 Tax Act to utilize indefinite deferred tax liabilities as a source of income against indefinite lived portions of the Company’s deferred tax assets. In 2019, as a result of a change in ownership under the provisions of Internal Revenue Code Section 382, the cumulative benefit of net operating losses was remeasured which resulted in tax expense to reverse the 2018 benefit recorded and record a benefit relative to losses incurred in 2019 after the date of the change in ownership. Deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect for years in which differences are expected to reverse. Significant components of the Company's deferred tax assets for federal income taxes consisted of the following: Deferred tax assets December 31, 2020 December 31, 2019 Net operating loss carryforwards $ 3,864,189 $ 1,504,496 Stock-based compensation 1,571,227 1,381,750 Orphan Drug credits 541,384 81,700 Lease liability 38,394 63,589 Capitalized start-up costs and other 10,709,631 9,187,898 Valuation allowance (14,906,646 ) (12,051,440 ) Deferred tax assets 1,818,179 167,993 Deferred tax liabilities Intangible assets (2,223,678 ) (2,223,678 ) Right of use asset (38,394 ) (63,589 ) Deferred tax liabilities (2,262,072 ) (2,287,267 ) Net deferred tax liability $ (443,893 ) $ (2,119,274 ) The Company does not have unrecognized tax benefits as of December 31, 2020 or December 31, 2019. The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. 60 DIFFUSION PHARMACEUTICALS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company had NOL carryforwards for federal and state income tax purposes at December 31, 2020 and 2019 of approximately: Combined NOL Carryforwards: December 31, 2020 December 31, 2019 Federal $ 15,013,388 $ 5,844,972 State 15,007,966 5,844,972 The pre-2018 net operating loss carryforwards begin expiring in 2020 for both federal and state income tax purposes. In November 2019, as a result of a change of ownership, under the provisions of Internal Revenue Code Section 382 and similar state provisions, the Company’s ability to utilize their net operating loss carryforwards to offset future income was limited. The Company recorded a valuation allowance against a portion of their deferred tax assets as of December 31, 2020 because of the uncertainty of their realization. A reconciliation of income tax benefit at the statutory federal income tax rate and income taxes as reflected in the consolidated financial statements is as follows: Rate reconciliation: December 31, 2020 December 31, 2019 Federal tax benefit at statutory rate (21.0 )% (21.0 )% State tax, net of Federal benefit (4.7 )% (2.5 )% Orphan drug credit (2.9 )% 25.3 % Change in valuation allowance 18.1 % (7.5 )% Stock compensation — % 8.6 % Other — % 0.1 % Total provision (10.5 )% 3.0 % The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company’s 2017 to 2019 tax years remain open and subject to examination. 10. Related Party Transactions The Company’s Director of Information Technologies is the son of the Chairman of the Board of Directors and he has held that position since December 2014. 11. Subsequent Events 2021 Warrant Exercises From January 1, 2021 through March 15, 2021, warrants were exercised by multiple holders to purchase a total of 4,230,000 shares of the Company's common stock for aggregate gross proceeds of approximately $2.2 million. 2021 Common Stock Offering In February 2021, the Company completed the February 2021 Offering in which it offered and sold 33,658,538 shares of its common stock in an underwritten, public offering for a purchase price to the public of $1.025 per share, inclusive of shares offered and sold pursuant to the exercise-in-full by the underwriter of its 30-day option to purchase additional shares. The February 2021 Offering resulted in aggregate net proceeds to the Company of $31.2 million, after deducting underwriting commissions, discounts, and expenses but prior to deducting other offering costs. In addition, at the closings of the February 2021 Offering, the Company issued to designees of the underwriter of the transaction warrants to purchase up to an aggregate of 1,682,927 shares of common stock to designees. The underwriter warrants have an exercise price of $1.28125 per share and a term of five years from the date of issuance. 61 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.