Dermata Therapeutics, Inc. 10-Q

Item 1: Financial Statements DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Balance Sheets September 30, 2022 December 31, 2021 (unaudited) Assets: Cash and cash equivalents $ 8,066,822 $ 10,798,806 Prepaid expenses and other current assets 908,067 825,134 Total assets $ 8,974,889 $ 11,623,940 Liabilities and Stockholders’ Equity: Liabilities: Accounts payable $ 483,741 $ 515,245 Accrued and other current liabilities 1,020,581 1,001,591 Total liabilities 1,504,322 1,516,836 Commitments and Contingencies (see Note 10) Stockholders’ Equity: Common Stock, par value $ 0.0001 , 250,000,000 shares authorized and 12,102,214 shares issued and outstanding as of September 30, 2022; and 90,000,000 shares authorized and 8,328,629 shares issued and outstanding as of December 31, 2021, respectively 1,210 833 Additional paid-in capital 51,392,942 46,088,546 Accumulated deficit ( 43,923,585 ) ( 35,982,275 ) Total stockholders’ equity 7,470,567 10,107,104 Total liabilities and stockholders’ equity $ 8,974,889 $ 11,623,940 The accompanying notes are an integral part of these financial statements. 3 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Statements of Operations (unaudited) For the three months ended September 30, For the nine months ended September 30, 2022 2021 2022 2021 Operating expenses: Research and development $ 1,553,295 $ 799,779 $ 4,761,686 $ 2,347,564 General and administrative 892,777 912,490 3,201,111 2,956,444 Total operating expenses 2,446,072 1,712,269 7,962,797 5,304,008 Loss from operations ( 2,446,072 ) ( 1,712,269 ) ( 7,962,797 ) ( 5,304,008 ) Other income and expenses: Interest (income) expense, net ( 21,486 ) 651 ( 21,486 ) 45,613 Net loss $ ( 2,424,586 ) $ ( 1,712,920 ) $ ( 7,941,311 ) $ ( 5,349,621 ) Deemed dividend upon the redemption of 5,221,156 shares of Series 1c preferred stock (see Note 6) $ - $ 269,038 $ - $ 269,038 Deemed dividend upon the amendment of terms of the Series 1d convertible preferred stock (see Note 6) $ - $ 2,293,199 $ - $ 2,293,199 Net loss attributable to common stockholders $ ( 2,424,586 ) $ ( 4,275,157 ) $ ( 7,941,311 ) $ ( 7,911,858 ) Net loss per share of common stock, basic and diluted $ ( 0.20 ) $ ( 0.86 ) $ ( 0.75 ) $ ( 2.69 ) Weighted-average basic and diluted common units/shares 12,276,394 4,980,306 10,622,277 2,945,351 The accompanying notes are an integral part of these financial statements. 4 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Statements of Stockholder’s Equity Unaudited Additional Total Common Stock Paid-in Accumulated Stockholders’ Shares Par Value Capital Deficit Equity Balance at December 31, 2021 8,328,629 $ 833 $ 46,088,546 $ ( 35,982,275 ) $ 10,107,104 Stock-based compensation - - 531,566 - 531,566 Net loss - - - ( 2,786,151 ) ( 2,786,151 ) Balance at March 31, 2022 8,328,629 $ 833 $ 46,620,112 $ ( 38,768,426 ) $ 7,852,519 Issuance of common stock and warrants, net of issuance costs 898,585 90 4,276,275 - 4,276,365 Issuance of common stock upon exercise of pre-funded warrants 875,000 87 - - 87 Issuance of restricted stock unit awards - - 55,625 - 55,625 Stock-based compensation - - 205,947 - 205,947 Net loss - - - ( 2,730,573 ) ( 2,730,573 ) Balance at June 30, 2022 10,102,214 $ 1,010 $ 51,157,959 $ ( 41,498,999 ) $ 9,659,970 Issuance of common stock upon exercise of pre-funded warrants 2,000,000 200 - - 200 Issuance of restricted stock unit awards - - 55,625 - 55,625 Stock-based compensation - - 179,358 - 179,358 Net loss - - - ( 2,424,586 ) ( 2,424,586 ) Balance at September 30, 2022 12,102,214 $ 1,210 $ 51,392,942 $ ( 43,923,585 ) $ 7,470,567 The accompanying notes are an integral part of these financial statements. 5 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Statements of Stockholder’s Equity (Deficit) Unaudited Class A Common Class B Common Series 1 Preferred Series 1a Preferred Series 1a Warrants Series 1b Preferred Units Amount Units Amount Units Amount Units Amount Units Amount Units Amount Balance at December 31, 2020 508,777 $ 10,430 1,767,477 $ 2,342,853 6,906,244 $ 6,833,877 5,018,750 $ 4,380,081 1,419,228 $ 723,431 6,500,000 $ 4,119,595 Series 1d Preferred Units issued - - - - - - - - - - - - Class B Common Units forfeited - - ( 22,494 ) - - - - - - - - - Conversion of Common Units to Common Stock ( 508,777 ) $ ( 10,430 ) ( 1,744,983 ) $ ( 2,342,853 ) - - - - - - - - Conversion of Preferred Units to Preferred Stock - - - - ( 6,906,244 ) $ ( 6,833,877 ) ( 5,018,750 ) $ ( 4,380,081 ) - - ( 6,500,000 ) $ ( 4,119,595 ) Conversion of Warrant Units to Preferred Stock Warrants - - - - - - - - ( 1,419,228 ) $ ( 723,431 ) - - Stock-based compensation - - - - - - - - - - - - Net loss - - - - - - - - - - - - Balance at March 31, 2021 - $ - - $ - - $ - - $ - - $ - - $ - Stock-based compensation - - - - - - - - - - - - Net loss - - - - - - - - - - - - Balance at June 30, 2021 - $ - - $ - - $ - - $ - - $ - - $ - Redemption of Series 1c preferred shares - - - - - - - - - - - - Conversion of Preferred Stock to Common Stock - - - - - - - - - - - - Conversion of Preferred Stock Warrants to Common Stock Warrants - - - - - - - - - - - - Conversion of Convertible Debt to Common Stock - - - - - - - - - - - - Issuance of Common Stock and warrants, net issuance costs - - - - - - - - - - - - Stock-based compensation - - - - - - - - - - - - Net loss - - - - - - - - - - - - Balance at September 30, 2021 - $ - - $ - - $ - - $ - - $ - - $ - The accompanying notes are an integral part of these financial statements. 6 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Statements of Stockholder’s and Member’s Equity (Deficit) Continued Unaudited Series 1c Preferred Series 1d Preferred Preferred Stock Preferred Stock Warrants Common Stock Additional Units Amount Units Amount Shares Par Value Shares Par Value Shares Par Value Paid-in Capital Accumulated Deficit Total Balance at December 31, 2020 46,553,188 $ 6,491,592 - - - - - - - - - $ ( 28,079,798 ) $ ( 3,177,939 ) Series 1d Preferred Units issued - - 6,065,989 $ 5,034,801 - - - - - - - - $ 5,034,801 Class B Common Units forfeited - - - - - - - - - - - - $ - Conversion of Common Units to Common Stock - - - - - - - - 1,911,009 $ 191 2,353,092 - $ - Conversion of Preferred Units to Preferred Stock ( 46,553,188 ) $ ( 6,491,592 ) ( 6,065,989 ) $ ( 5,034,801 ) 71,044,171 $ 7,104 - - - - 26,852,842 - $ - Conversion of Warrant Units to Preferred Stock Warrants - - - - - - 1,419,228 $ 142 - - 723,289 - $ - Stock-based compensation - - - - - - - - - - 1,160,049 - $ 1,160,049 Net loss - - - - - - - - - - - $ ( 2,304,908 ) $ ( 2,304,908 ) Balance at March 31, 2021 - $ - - $ - 71,044,171 $ 7,104 1,419,228 $ 142 1,911,009 $ 191 31,089,272 $ ( 30,384,706 ) $ 712,003 Stock-based compensation - - - - - - - - - - 113,987 - $ 113,987 Net loss - - - - - - - - - - - $ ( 1,331,792 ) $ ( 1,331,792 ) Balance at June 30, 2021 - $ - - $ - 71,044,171 $ 7,104 1,419,228 $ 142 1,911,009 $ 191 31,203,259 $ ( 31,716,498 ) $ ( 505,802 ) Redemption of Series 1c preferred shares - - - - ( 5,221,156 ) $ ( 522 ) - - - - ( 999,478 ) - $ ( 1,000,000 ) Conversion of Preferred Stock to Common Stock - - - - ( 65,823,015 ) $ ( 6,582 ) - - 3,813,973 $ 381 6,200 - $ - Conversion of Preferred Stock Warrants to Common Stock Warrants - - - - - - ( 1,419,228 ) $ ( 142 ) - - 142 - $ - Conversion of Convertible Debt to Common Stock - - - - - - - - 32,219 $ 3 180,430 - $ 180,434 Issuance of Common Stock and warrants, net issuance costs - - - - - - - - 2,571,428 $ 257 15,385,932 - $ 15,386,189 Stock-based compensation - - - - - - - - - - 142,655 - $ 142,655 Net loss - - - - - - - - - - - $ ( 1,712,920 ) $ ( 1,712,920 ) Balance at September 30, 2021 - $ - - $ - - $ - - $ - 8,328,629 $ 833 45,919,140 $ ( 33,429,418 ) $ 12,490,555 The accompanying notes are an integral part of these financial statements. 7 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Statements of Cash Flows (unaudited) For the nine months ended September 30, 2022 2021 Cash flows from operating activities: Net loss $ ( 7,941,311 ) $ ( 5,349,621 ) Adjustments to reconcile net loss to net cash used in operating activities: Stock-based compensation 709,435 1,416,691 Amortization of debt discount costs - 14,126 Increase/(decrease) in cash resulting from changes in: Prepaid expenses and other current assets ( 82,933 ) ( 1,007,393 ) Accounts payable ( 31,504 ) 665,587 Accrued and other current liabilities 337,677 371,127 Net cash used in operating activities: ( 7,008,636 ) ( 3,889,483 ) Cash flows from financing activities: Proceeds from issuance of common stock and warrants, net of issuance costs 4,276,365 15,386,189 Proceeds from issuances of common stock upon exercises of pre-funded warrants 287 - Redemption of Series 1c preferred stock - ( 1,000,000 ) Payments on debt - ( 556,482 ) Net proceeds from issuance of convertible subordinated promissory notes - 1,562,717 Proceeds from issuance of Series 1d preferred units - 570,000 Net cash provided by financing activities: 4,276,652 15,962,424 Net increase (decrease) in cash and cash equivalents ( 2,731,984 ) 12,072,941 Cash and cash equivalents at beginning of period 10,798,806 530,400 Cash and cash equivalents at end of period $ 8,066,822 $ 12,603,341 Supplemental disclosures: Cash paid for interest $ - $ 1,420 Cash paid for taxes $ 800 $ 1,400 Non-cash financing activities: Conversion of common and preferred units and warrants to common and preferred stock and warrants $ - $ 29,936,660 Conversion of convertible subordinated promissory notes to Series 1d preferred units $ - $ 4,464,801 Deemed dividend upon amendment to the terms of the Series 1d convertible preferred stock $ - $ 2,293,199 Conversion of convertible subordinated promissory notes and accrued interest to common shares at IPO $ - $ 180,434 Conversion of preferred stock to common stock at IPO $ - $ 6,582 The accompanying notes are an integral part of these financial statements. 8 Table of Contents DERMATA THERAPEUTICS, INC. (FORMERLY DERMATA THERAPEUTICS, LLC) Notes to Financial Statements (unaudited) 1. Organization and Basis of Presentation Dermata Therapeutics, Inc., (the “Company”), was formed in December 2014 as a Delaware limited liability company (“LLC”) under the name Dermata Therapeutics, LLC. On March 24, 2021, the Company converted from an LLC to a Delaware C-corporation and changed its name to Dermata Therapeutics, Inc. Any references in these Notes to Financial Statements to equity securities as “units” refer to pre-conversion equity securities and any references to “shares” or “stock” in these Notes to Financial Statements refer to post-conversion equity securities. The Company is a clinical-stage biotechnology company focused on the treatment of medical and aesthetic skin conditions and diseases. Initial Public Offering On August 17, 2021, the Company completed its initial public offering (“IPO”), in which it sold 2,571,428 shares of its common stock together with 2,571,428 warrants to purchase one share of common stock with an exercise price of $ 7.00 per share, at a combined offering price of $ 7.00 . Additionally, the underwriters exercised their option to purchase an additional 385,714 warrants to purchase common stock with an exercise price of $ 7.00 per share. The Company received net cash proceeds of approximately $ 15.4 million from the IPO after deducting underwriters’ discounts and offering expenses of approximately $ 2.6 million. Each of the following occurred in connection with the completion of the IPO in August 2021: - The sale of 2,571,428 shares of common stock along with 2,957,142 warrants to purchase common stock. - The conversion of 65,823,015 shares of convertible preferred stock into an aggregate of 3,813,973 shares of common stock. - The conversion of $ 175,000 principal amount of outstanding convertible promissory notes and accrued interest of $ 5,434 into 32,219 shares of common stock. - The conversion of 1,419,228 Series 1a preferred warrants into 69,212 warrants exercisable into common stock. Each purchaser in the IPO received one share of common stock and one warrant to purchase one share of common stock at a combined offering price of $ 7.00 . Each warrant to purchase common stock entitles the holder to purchase one share of common stock, are immediately exercisable, and expire five years from the date of issuance. The Company evaluated the terms of the warrants issued and determined that they should be classified as equity instruments. The Company’s shares of common stock and warrants are listed on the Nasdaq Stock Market LLC under the symbols “DRMA,” and “DRMAW,” respectively, and both began trading in August 2021. After the IPO, there were no shares of preferred stock or preferred stock warrants outstanding. Prior to the IPO, the Company had 1,911,009 shares of common stock outstanding after giving effect for the Company’s reverse stock split in July 2021. Reverse Stock Split On July 1, 2021, the Company effected a reverse split of shares of the Company’s common stock at a ratio of 1-for-20.5 pursuant to an amendment to the Company’s certificate of incorporation approved by the Company’s board of directors and stockholders. The par value was not adjusted as a result of the reverse split. All issued and outstanding common stock shares and per share amounts contained in the financial statements have been retroactively adjusted to reflect this reverse stock split for all periods presented, and the conversion ratios for the Company’s outstanding preferred stock was adjusted accordingly. See Note 6 – Equity Securities for additional information. 9 Table of Contents Liquidity and Going Concern Uncertainty Since its inception, the Company has devoted substantially all of its resources to research and development activities and has not generated any revenue or commercialized any product candidates. As of September 30, 2022, cash and cash equivalents totaled $ 8.1 million and the Company had an accumulated deficit of $ 43.9 million. For the nine months ended September 30, 2022 and the year ended December 31, 2021, the Company used cash of $ 7.0 million and $ 5.7 million, respectively, in operations. The Company’s cash balances are expected to fund operations into the third quarter of 2023. The Company anticipates that it will continue to incur net losses for the foreseeable future. These factors raise substantial doubt about the Company’s ability to continue as a going concern for the one-year period following the date that these financial statements were issued. Historically, the Company’s principal sources of cash have included proceeds from the issuance of common and preferred equity units and proceeds from the issuance of debt. The Company’s principal uses of cash have included cash used in operations and payments for license rights. The Company expects that the principal uses of cash in the future will be for continuing operations, funding of research and development, conducting preclinical studies and clinical trials, and general working capital requirements. The Company expects that as research and development expenses continue to grow, it will need to raise additional capital to sustain operations and research and development. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. Management’s Plan to Continue as a Going Concern To continue as a going concern, the Company will need, among other things, to raise additional capital resources. Until the Company can generate significant cash from operations, management’s plans to obtain such resources for the Company include proceeds from offerings of the Company’s equity securities or debt, or transactions involving product development, technology licensing or collaboration. Management can provide no assurance that any sources of a sufficient amount of financing or collaboration agreements will be available to the Company on favorable terms, if at all. Additionally, the COVID-19 pandemic continues to evolve and has already disrupted global financial markets. The Company’s ability to raise additional capital may be adversely impacted by potential worsening of global economic conditions and the recent disruptions to, and volatility in, the credit and financial markets in the United States and worldwide resulting from the pandemic. If the disruption persists or deepens, the Company could experience an inability to access additional capital. The Company has raised additional capital through the initial public offering of its common stock and warrants and through a private placement financing; however, management’s current plans do not alleviate substantial doubt about the Company’s ability to continue as a going concern. Basis of Presentation The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, since they are interim statements, the accompanying financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting of normal recurring adjustments) that are necessary for a fair statement of the financial position, results of operations, cash flows, and stockholders’ equity for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ materially from those estimates. 10 Table of Contents 2. Summary of Significant Accounting Policies Use of Estimates The Company’s financial statements are prepared in accordance with GAAP. The preparation of the Company’s financial statements requires management to make estimates and assumptions that impact the reported amounts of assets, liabilities, and expenses and disclosure of contingent assets and liabilities in the financial statements and accompanying notes. On an ongoing basis, management evaluates these estimates and judgments, including those related to accrued research and development expenses, stock-based compensation, and the estimated fair values of equity instruments. Management evaluates its estimates on an ongoing basis. The Company bases its estimates on various assumptions that it believes are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Segment Information Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company and the Company’s chief operating decision maker view the Company’s operations and manage its business in one operating segment, which is the business of developing and commercializing pharmaceuticals. The Company operates in only one segment. Deferred Financing Costs The Company capitalizes certain legal, accounting, and other fees and costs that are directly attributable to in-process equity financings as deferred offering costs until such financings are completed. Upon the completion of an equity financing, these costs are recorded as a reduction of additional paid-in capital of the related offering. Upon the completion of the IPO in August 2021, approximately $ 2.6 million of offering costs related to the IPO were reclassified to additional paid-in capital. As of December 31, 2021, the Company had deferred financing costs of $ 0.06 million and as of September 30, 2022, the Company had no deferred financing costs. Cash and Cash Equivalents The Company deposits its cash with reputable financial institutions that are insured by the Federal Deposit Insurance Corporation (“FDIC”). This cash is held in checking, cash sweep, and money market accounts. At times, deposits held may exceed the amount of insurance provided by the FDIC. The Company maintains an insured cash sweep account in which cash from its main operating checking account is invested overnight in highly liquid, short-term investments. The Company considers all highly liquid investments with a maturity date of 90 days or less at the date of purchase to be cash equivalents. The Company has not experienced any losses in its cash and cash equivalents and believes they are not exposed to significant credit risk. Fair Value Measurement The Company uses a three-tier fair value hierarchy to prioritize the inputs used in the Company’s fair value measurements. These tiers include Level 1, defined as observable inputs such as quoted prices in active markets for identical assets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The Company believes the carrying amount of cash and cash equivalents, accounts payable, accrued expenses and debt approximate their estimated fair values due to the short-term maturities of these financial instruments. Interest Income Interest income consists of interest income earned on cash equivalents from interest bearing demand accounts. 11 Table of Contents Patent Costs Patent costs related to obtaining and maintaining patent protection in both the United States and other countries are expensed as incurred. Patents costs are classified as general and administrative expenses. Research and Development Research and development costs consist of expenses incurred in connection with the development of the Company’s product candidates. Such expenses include expenses incurred under agreements with contract research organizations, manufacturing and supply scale-up expenses and the cost of acquiring and manufacturing preclinical and clinical trial supply, outsourced laboratory services, including materials and supplies used to support the Company’s research and development activities, and payments made for license fees and milestones that have not been demonstrated to have commercial value. Such costs are expensed in the periods in which they are incurred. Upfront payments and milestone payments for licensed technology are expensed as research and development as incurred or when the milestone is achieved or is determined to be probable of being achieved. Advanced payments for goods or services to be received in the future for research and development activities are recorded as prepaid expenses and expensed as the related goods are received or services are performed. Income Taxes From inception until March 24, 2021, the Company operated as a limited liability company taxed as a partnership. Therefore, any income tax liability or benefit through that date accrued to the Company’s members. Since March 24, 2021, the Company has operated as a C-Corporation and accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. The Company recognizes net deferred tax assets to the extent that the Company believes these assets are more likely than not to be realized. In making such a determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If management determines that the Company would be able to realize its deferred tax assets in the future in excess of their net recorded amount, management would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. The Company records uncertain tax positions on the basis of a two-step process whereby (1) management determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, management recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes interest and penalties related to unrecognized tax benefits within income tax expense. Any accrued interest and penalties are included within the related tax liability. Stock-Based Compensation In March 2021, the Company’s board of directors and shareholders approved the 2021 Omnibus Equity Incentive Plan (“the 2021 Plan”). For stock options granted under the 2021 Plan, the Company measures and recognizes compensation expense for all stock-based awards made to employees, directors, and non-employees, based on estimated fair values recognized using the straight-line method over the requisite service period. The fair value of options to purchase common stock granted to employees is estimated on the grant date using the Black-Scholes valuation model. The calculation of stock-based compensation expense requires that the Company make certain assumptions and judgments about variables used in the Black-Scholes model, including the expected term of the stock-based award, expected volatility of the underlying common stock, dividend yield, and the risk-free interest rate. Forfeitures are accounted for in the period they occur. Restricted stock units (“RSUs”) granted under the 2021 Plan are measured at the grant date fair value of the common stock, with corresponding compensation expense recognized ratably over the requisite service period. Refer to Note 7- Equity Incentive Plan for further discussion. 12 Table of Contents Comprehensive Loss Comprehensive loss includes net loss and other comprehensive income (loss) for the periods presented. The Company did not have other comprehensive income (loss) items such as unrealized gains and losses and so for the three and nine months ended September 30, 2022, and September 30, 2021, comprehensive loss was equal to the net loss. Net Loss Per Common Unit/Share On March 24, 2021, the Company converted from an LLC to a C-corporation. Upon the conversion, each outstanding common unit and preferred unit was converted into one share of common stock and preferred stock, respectively. Common units had similar rights and characteristics of common stock issued upon the conversion. In calculating net loss per share, the Company retrospectively applied the effects of the conversion to the number of common units outstanding prior to the conversion. Net loss per share for periods prior to the conversion to a C-corporation refers to net loss per common unit. Basic net loss per unit/share is calculated by dividing net loss attributable to common unitholders or shareholders by the weighted-average number of units or shares outstanding during the period, contingently issuable restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock, and pre-funded warrants because their exercise requires only nominal consideration for the delivery of shares (collectively, “basic shares”), without consideration of common unit or share equivalents. Diluted net loss per unit or share is calculated by adjusting basic shares outstanding for the dilutive effect of common unit or share equivalents outstanding for the period. For purposes of the diluted net loss per unit or share calculation, preferred units or shares, profit interests, and warrants to purchase preferred units or shares are considered to be common unit or share equivalents but are excluded from the calculation of diluted net loss per common unit or share if their effect would be anti-dilutive. As the Company has reported a net loss for the periods presented, diluted net loss per common unit or share is the same as the basic net loss per common unit or share for the periods presented. Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Net loss $ ( 2,424,586 ) $ ( 1,712,920 ) $ ( 7,941,311 ) $ ( 5,349,621 ) Deemed dividend upon redemption of 5,221,156 shares of Series 1c convertible preferred stock $ - $ 269,038 $ - $ 269,038 Deemed dividend upon amendment of the terms to the Series 1d convertible preferred stock $ - $ 2,293,199 $ - $ 2,293,199 Net loss attributable to common stockholders $ ( 2,424,586 ) $ ( 4,275,157 ) $ ( 7,941,311 ) $ ( 7,911,858 ) Basic and diluted net loss per common unit/share $ ( 0.20 ) $ ( 0.86 ) $ ( 0.75 ) $ ( 2.69 ) Weighted-average basic and diluted common units/shares 12,276,394 4,980,306 10,622,277 2,945,351 The common unit or share equivalents that are not included in the calculation of diluted net loss per common unit or share but could potentially dilute basic earnings per share in the future are as follows: As of September 30, 2022 2021 Common stock options 1,056,326 523,199 Common stock warrants 6,993,813 3,091,657 Total potentially dilutive securities 8,050,139 3,614,856 13 Table of Contents Recent Accounting Pronouncements From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standard-setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption. 3. Balance Sheet Details The following provides certain balance sheet details: September 30, December 31, 2022 2021 Prepaid expenses and other current assets Prepaid insurance $ 806,661 $ 769,416 Prepaid research and development costs 52,100 - Prepaid other 36,413 - Interest receivable 12,893 - Deferred offering costs - 55,718 Total prepaid expenses and other current assets $ 908,067 $ 825,134 Accrued and other current liabilities Accrued research and development costs $ 633,293 $ 235,384 Accrued compensation and benefits 317,089 766,207 Accrued legal fees 13,801 - Accrued board compensation 55,625 - Accrued other 773 - Total accrued and other current liabilities $ 1,020,581 $ 1,001,591 4. Subordinated Convertible Promissory Notes In July and October 2020, the Company issued an aggregate of $ 3,000,000 of subordinated convertible promissory notes (the “Notes”). Notes in the amount of $ 1,145,000 were issued to existing investors who are also related parties (See Note 11 - Related Parties), $ 1,730,000 were issued to existing investors who are not related parties and notes in the amount of $ 125,000 were issued to new investors. The Notes bore interest at 4 % per annum and were to mature on July 17, 2021 . The Notes were subordinated to the Company’s long-term debt and were convertible into a qualified Series A financing of at least $ 10 million at a 20 % discount to the lowest price per unit paid by investors for that financing. Under authoritative accounting guidance, this contingent beneficial conversion feature was to be measured and recognized when the contingency is resolved. The Notes were recorded upon issuance net of debt discount costs of $ 28,301 . The Company recognized $ 14,126 of amortized debt discount costs during the nine months ended September 30, 2021. On January 27, 2021, the Company amended the terms of the Notes to increase the maximum amount of convertible promissory notes to be issued from $ 3,000,000 to $ 5,000,000 , to allow for the conversion of the convertible promissory notes into shares of common stock upon a Qualified Initial Public Offering with aggregate gross proceeds to the Company of at least $ 10,000,000 at a 20 % discount to the lowest price per share paid by investors for that financing and to extend the maturity date to December 31, 2021 . In connection with this amendment, Notes in the amount of $ 1,255,000 were issued to existing investors who are also related parties (See Note 11 - Related Parties) and $ 311,000 were issued to existing investors who are not related parties. 14 Table of Contents In March 2021, the Company further amended the terms of the Notes to allow for the conversion of the Notes into Series 1d Preferred Units at the same price as purchasers of Series 1d Preferred Units. As of March 15, 2021, $ 4,391,000 of the Notes, along with related interest of $ 73,801 , were converted to 5,379,247 Series 1d Preferred Units. Since the Notes did not convert at a discount, there was no beneficial conversion feature. The Company considers the above modification of the Notes in March 2021 to be a substantial modification requiring extinguishment accounting under Accounting Standards Codification (“ASC”) 470-50-40-10. Based upon an independent valuation of the reacquisition price of the Notes, the difference between the reacquisition price and the net carrying amount of the Notes immediately prior to the modification is not material to the financial statements. In connection with the Company’s IPO in August 2021, the outstanding principal of the Notes and accrued interest totaling $ 180,434 converted into 32,219 shares of common stock. Upon this conversion, since the conversion contained a 20 % discount, the Company measured the beneficial conversion feature and determined that it was not material to the financial statements. As of December 31, 2021, and September 30, 2022, the Company had no promissory notes outstanding. 5. Long-Term Debt In February 2017, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (“SVB”) whereas SVB agreed to provide term loans to the Company in two tranches. The first tranche of $ 2,500,000 was drawn in February 2017 and bore interest at a rate of 1.5 % above the prime rate, which was 3.25 % as of December 31, 2020, with principal and interest payable monthly through February 9, 2021. The second tranche was not utilized. In connection with the Loan and Security Agreement, SVB also received warrant units to purchase, at any time after February 9, 2017 and prior to February 9, 2027, 187,978 Series 1a Preferred Units or the equivalent Series A Preferred Units had they purchased Series 1a Preferred Units, if Series A Preferred Units are issued, at a price of $ 1.00 per unit. The estimated fair value of these warrant units of $ 104,630 (See Note 6 – Equity Securities), as well as costs associated with the term loan, including provision for a final payment of $ 225,000 , were recorded as a discount to outstanding debt and amortized to interest expense utilizing the effective interest method over the underlying term of the loan. In June 2019, the Company and SVB entered into a First Amendment to the Loan and Security Agreement whereby if the Company did not achieve certain capital milestones by December 1, 2019, term loan principal payments would be deferred from December 21, 2019 through May 1, 2020 with the deferred principal payments being payable in equal monthly installments, in addition to those principal payments already scheduled to be paid, starting on June 1, 2020 and extending through the February 9, 2021 maturity date of the term loan. In addition, if those principal payments were deferred for that six-month period, a non-refundable amendment fee of $ 100,000 would be due and payable on the earliest to occur of the maturity date, the prepayment of the term loan or the occurrence of an event of default. The capital milestones were not achieved by December 1, 2019 and, therefore, the defined principal repayments were deferred. The non-refundable amendment fee of $ 100,000 , as well as $ 12,280 of costs associated with the amendment, were recorded as a discount to outstanding debt and were amortized to interest expense utilizing the effective interest method over the remaining underlying term of the loan. In January and February 2021, the Company paid the final principal payments of $ 231,482 under the SVB Loan and Security Agreement. The Company also paid the final payment fee of $ 225,000 in February 2021 and the amendment fee of $ 100,000 in March 2021. For the nine months ended September 30, 2021, the Company paid a total of $ 556,482 to SVB as final payments for its long-term debt. As of December 31, 2021, and September 30, 2022, the Company had no long-term debt outstanding. 15 Table of Contents 6. Equity Securities Common Stock and Preferred Stock On March 24, 2021, the Company entered into a Plan of Conversion (“Conversion”) whereby the Company converted from an LLC under the laws of the State of Delaware to a Delaware C-corporation with the name Dermata Therapeutics, Inc. In connection with the Conversion, each fully paid preferred and common unit in the LLC was converted into a like number of shares of preferred and common stock of the Company with a par value of $ 0.0001 per share. The Shares issued had the same rights, preferences and privileges that had accrued to the pre-converted Units. Any references in these Notes to Financial Statements to equity securities as “units” refer to pre-conversion equity securities and any references to “shares” or “stock” in these Notes to Financial Statements refer to post-conversion equity securities. On July 1, 2021, the Company effected a reverse split of shares of the Company’s common stock at a ratio of 1-for-20.5 pursuant to an amendment to the Company’s certificate of incorporation approved by the Company’s board of directors and stockholders. The par value was not adjusted as a result of the reverse split. All issued and outstanding common stock share and per share amounts contained in the financial statements have been retroactively adjusted to reflect this reverse split for all periods presented. On August 17, 2021, the Company completed its IPO, in which it sold 2,571,428 shares of its common stock together with 2,571,428 warrants to purchase one share of common stock with an exercise price of $ 7.00 per share at a combined offering price of $ 7.00 . Additionally, the underwriters exercised their option to purchase an additional 385,714 warrants with an exercise price of $ 7.00 per warrant. The Company received net cash proceeds of approximately $ 15.4 million from the IPO after deducting underwriters’ discounts and offering expenses of approximately $ 2.6 million. Each of the following occurred in connection with the completion of the IPO in August 2021: - The sale of 2,571,428 shares of common stock along with 2,957,142 warrants to purchase common stock. - The conversion of 65,823,015 shares of convertible preferred stock into an aggregate of 3,813,973 shares of common stock. - The conversion of $ 175,000 principal amount of outstanding convertible promissory notes and accrued interest of $ 5,434 into 32,219 shares of common stock. - The conversion of 1,419,228 Series 1a preferred warrants into 69,212 warrant shares exercisable into common stock. After the IPO, there were no shares of preferred stock or preferred stock warrants outstanding. Prior to the IPO, the Company had 1,911,009 shares of common stock outstanding after giving effect for the Company’s reverse stock split in July 2021. On April 25, 2022, the Company closed a private placement (“PIPE”), in which it sold 898,585 shares of its common stock together with 2,875,000 pre-funded warrants to purchase one share of common stock with an exercise price of $ 0.0001 per share (“Pre-funded Warrant”), and 3,773,585 warrants to purchase one share of common stock with an exercise price of $ 1.325 per share (“PIPE Common Warrant”) at a combined offering price of $ 1.325 . The Company received net cash proceeds of approximately $ 4.3 million from the PIPE after deducting underwriters’ discounts and offering expenses of approximately $ 0.7 million. The PIPE Common Warrant related to this private placement will expire on May 12, 2027. During the quarter ended June 30, 2022, 875,000 of the Pre-funded Warrants were exercised. Further, during the quarter ended September 30, 2022, 2,000,000 of the Pre-funded Warrants were exercised. No Pre-Funded Warrants were outstanding as of September 30, 2022. The Company’s total common stock issued and outstanding was 12,102,214 and 8,328,629 shares as of September 30, 2022, and December 31, 2021, respectively. Series 1 Preferred Units From the Company’s formation on December 8, 2014 through 2016, the Company issued 6,906,244 Series 1 Preferred Units for net consideration of $ 6,833,877 . The Company’s Series 1 Preferred Units were converted to preferred stock during the first quarter of 2021. Additionally, in August 2021, the Company converted all preferred stock into common stock. No Series 1 Preferred Units were outstanding as of December 31, 2021 and September 30, 2022. 16 Table of Contents Series 1a Preferred Units In 2016, the Company issued 5,000,000 Series 1a Preferred Units in exchange for cash of $ 5,000,000 and net of issuance costs of $ 19,868 . Purchasers of the Series 1a Preferred Units also received 1,250,000 Warrant Units to purchase an additional amount of Series 1a Preferred Units. The estimated fair value of the warrant units was recorded as a separate component of members’ equity (deficit) in the accompanying balance sheet as of December 31, 2020 with an offset to the Series 1a proceeds. In June 2020, 18,750 of the warrants were exercised for consideration of $ 18,750 , which consideration was received in July 2020. The Company’s Series 1a Preferred Units were converted to preferred stock during the first quarter of 2021. Additionally, in August 2021, the Company converted all preferred stock into common stock. No Series 1a Preferred Units were outstanding as of December 31, 2021 and September 30, 2022. Series 1b Preferred Units In 2018, the Company issued 6,500,000 Series 1b Preferred Units in exchange for cash of $ 6,500,000 and net of issuance costs of $ 40,405 . Purchasers of the Series 1b Preferred Units also received 1,268,279 Class B Common Units. The estimated fair value of the Class B Common units has been recorded as a component of members’ equity (deficit) in the accompanying balance sheet as of December 31, 2020 with an offset to the Series 1b proceeds. The Company’s Series 1b Preferred Units were converted to preferred stock during the first quarter of 2021. Additionally, in August 2021, the Company converted all preferred stock into common stock. No Series 1b Preferred Units were outstanding as of December 31, 2021 and September 30, 2022. Series 1c Preferred Units On June 14, 2019, the Company closed participation in a $ 5,785,000 Series 1c financing from current and new investors. As of December 31, 2019, cash of $ 5,535,000 , including $ 150,000 from the conversion of a convertible note issued to a Managing Member of the Company for a loan made to the Company, net of issuance costs of $ 25,857 , had been received. The accrued interest on the convertible note in the amount of $ 1,487 was also converted into Series 1c Preferred Units. The remaining balance of $ 250,000 committed to the financing was paid in the amounts of $ 125,000 in May 2020 and $ 125,000 in June 2020. In June 2019, 5,221,156 Series 1c Preferred Units were issued in connection with the settlement and license agreement, and in July 2021, the Company redeemed these units/shares in connection with an amendment to the settlement and license agreement. See Note 9 – License Agreements for more information. The Company’s Series 1c Preferred Units were converted to preferred stock during the first quarter of 2021. Additionally, in August 2021, the Company converted all preferred stock into common stock. No Series 1c Preferred Units were outstanding as of December 31, 2021 and September 30, 2022. Series 1d Preferred Units In March 2021, the Company issued 686,742 Series 1d Preferred Units at a cost of $ 0.83 per unit for total proceeds of $ 570,000 . In addition, as described in Note 4 – Subordinated Convertible Promissory Notes, as of March 15, 2021, $ 4,391,000 of convertible promissory notes, along with related interest of $ 73,801 , were converted into 5,379,247 Series 1d Preferred Units. The outstanding Series 1d Preferred Units were converted to preferred stock during the first quarter of 2021. Additionally, in August 2021, the Company converted all preferred stock into common stock. No Series 1d Preferred Units were outstanding as of December 31, 2021 and September 30, 2022. 17 Table of Contents Class A Common Units During 2014 and 2015, the Company issued 508,777 Class A Common Units in exchange for consideration of $ 10,430 . The Class A Common Units outstanding converted to common stock during the first quarter of 2021. No Class A Common Units were outstanding as of December 31, 2021 and September 30, 2022. Class B Common Units The Company had 1,767,477 Class B Common Units outstanding as of December 31, 2020. This includes 133,953 Class B Common Units issued for consideration of $ 2,853 and 1,268,279 Class B Common Units issued in connection with the issuance of the Series 1b Preferred Units, which were assigned an estimated fair value of $ 2,340,000 . The remaining 365,245 Class B Common Units were issued as a profits interest as that term is defined by Revenue Procedure 93-27, 1993-2 C.B. 343, as clarified by Revenue Procedure 2001-43, 2001-2 C.B. 191, with participation thresholds from $ 0.001 to $ 0.36 . During the first quarter 2020, the Company issued 2,439 Class B Common Units, all of which represented a profits interest. During the first quarter of 2021, 22,494 Class B Common Units were forfeited as a result of employee resignations. The remaining Class B Common Units outstanding converted to common stock during the first quarter of 2021. No Class B Common Units were outstanding as of December 31, 2021 and September 30, 2022. Liquidation Preference Prior to the Company’s IPO in August 2021, the Company’s preferred units were subject to liquidation preferences contained herein. So long as there were no Series A Preferred Units outstanding at the time of a liquidity event, any liquidity event proceeds would have been distributed as follows: First, the Series 1d Preferred Units had a two times preference in liquidation over the Series 1c Preferred Units and then participated with the Series 1c, 1b and 1a Preferred Units once the Series 1c Preferred Unit preferences had been satisfied. Second, proceeds to Series 1c Preferred Unit holders sufficient to cover two times their Series 1c investment; third, proceeds to Series 1, Series 1a, Series 1b, Series 1c, and Series 1d Preferred Unit holders sufficient to cover interest at the rate of 8 % per annum on the Series 1 Preferred Units, the Series 1a Preferred Units, the Series 1b Preferred Units, the Series 1c Preferred Units, and Series 1d Preferred Units; fourth, proceeds to the Series 1, Series 1a, Series 1b and Series 1c Preferred Unit holders sufficient to cover the unit value of Series 1 Preferred Units, Series 1a Preferred Units, Series 1b Preferred Units, Series 1c Preferred Units, and Series 1d Preferred Units; fifth, to Class A and Class B Common holders proceeds sufficient to cover their pro-rata portion of distributions made to Series 1, Series 1a, Series 1b, Series 1c, and Series 1d Preferred Unit holders, provided that no Class B Common Units would share in any distribution until after the point at which the amount per Class A Common Unit exceeds the amount of such Class B Common Unit’s Participation Threshold; and sixth, a pro-rata distribution of the remaining proceeds to all equity holders. Upon the issuance of Series A Preferred Units, each Series 1 Preferred Unit, each Series 1a Preferred Unit, each Series 1b Preferred Unit, each Series 1c Preferred Unit and each Series 1d Preferred Unit would have automatically converted into the number of Series A Preferred Units equal to the sum of the unit value of the Series 1, Series 1a, Series 1b, Series 1c or Series 1d Preferred Units plus all accumulated preferred return as of the conversion date that would have been due with respect to such Series 1, Series 1a, Series 1b, Series 1c or Series 1d Preferred Units in the case of a liquidity event. As of December 31, 2021 and September 30, 2022, no Series A Preferred Units had been issued, and no preferred stock remained outstanding. Conversion Rights Prior to the Company’s IPO in August 2021, the Company’s preferred units were subject to conversion rights contained herein. Upon the first issuance by the Company of any Series A Preferred Units, each Series 1 Preferred Unit and each Series 1a Preferred Unit and each Series 1b Preferred Unit and each Series 1c Preferred Unit and each Series 1d Preferred Unit would have automatically been converted into the number of Series A Preferred Units equal to the sum of the Unit Value with respect to such Series 1 Preferred Unit or Series 1a Preferred Unit or Series 1b Preferred Unit or Series 1c Preferred Unit or Series 1d Preferred Unit as of the conversion date divided by the product of 0.80 multiplied by the Unit Value of the Series 1 Preferred Units or Series 1a Preferred Units or Series 1b Preferred Units or Series 1c Preferred Units or Series 1d Preferred Unit issued on the conversion date. The Series A Preferred Units issued to the Series 1 Preferred Members and Series 1a Preferred Members and Series 1b Preferred Members and Series 1c Preferred Members and Series 1d Preferred Members upon conversion of such Series 1 Preferred Units and Series 1a Preferred Units and such Series 1b Preferred Units and Series 1c Preferred Units and Series 1d Preferred Units would have had the same rights, privileges and preferences as the other Series A Preferred Units issued by the Company on the conversion date. The Company considered the classification of the Preferred Units and concluded that they were appropriately included as a component of equity since each class of Preferred Units participates in the same form of consideration received upon a change in control. As of December 31, 2021 and September 30, 2022, no preferred units or stock remained outstanding. 18 Table of Contents Stockholders’ Agreements On March 24, 2021, in connection with the conversion of Dermata Therapeutics, LLC into a Delaware corporation, the Company entered into a Stockholders’ Agreement (as amended, the Stockholders’ Agreement) with all of its then-existing stockholders, including Proehl Investment Ventures, LLC and Hale Biopharma Ventures, LLC. The Stockholders’ Agreement among other things, provided for certain restrictions on transfer of the Company’s shares of capital stock, set forth agreements and understandings with respect to how shares of its capital stock held by the stockholders party thereto will have been voted on, or tendered in connection with, an acquisition of the Company and provided for certain voting rights with respect to the election of directors. In addition, pursuant to the Stockholders’ Agreement, holders of the Company’s Series 1a Preferred Stock were entitled to purchase, at any time prior to March 14, 2026, such number of shares of the Company’s Series 1a Preferred Stock as such Series 1a Stockholder shall request, up to an aggregate number of shares of Series 1a Preferred Stock not to exceed the product of 25% and the aggregate number of shares Series 1a Preferred Stock then held by such Series 1a Stockholder (or the Series 1a Preferred Warrant Rights). The shares of Series 1a Preferred Stock purchased pursuant to any Series 1a Preferred Warrant Right had a per share purchase price of $ 20.50 (subject to appropriate adjustment in the event of any stock dividend, stock split, combination, or other similar recapitalization). Upon the consummation of the Company’s IPO of common stock, each Series 1a Preferred Stock Warrant became exercisable for the same number of shares of Common Stock with the same per share exercise price of $ 20.50 per share (subject to appropriate adjustment in the event of any stock dividend, stock split, combination, or other similar recapitalization). The Stockholders’ Agreement would have automatically terminated upon the earliest of (a) immediately prior to the consummation of the Company’s initial public offering of common stock, and (b) the consummation of a sale of the Company, subject to certain conditions. The Company completed the IPO of common stock in August 2021, thereby terminating the Stockholders’ Agreement. On June 29, 2021, with effectiveness on July 1, 2021, the Company’s board of directors amended its Certificate of Incorporation to adjust the conversion price and certain conversion mechanics of the Company’s issued and outstanding Series 1d Preferred Stock, whereby each share of Series 1d Preferred stock would convert into such number of Common Stock as determined by dividing (i) the product of (a) the Original Issue Price for the Series 1d Preferred Stock, multiplied by (b) 1.2, rounded to the nearest whole cent, by (ii) the 80 % of the initial public per share offering price in the IPO. The Series 1d conversion shall not be subject to further adjustment for any stock split. On June 29, 2021, with effectiveness on July 1, 2021, the Company’s board of directors approved an amendment to the 2021 Plan to increase the number of shares of Common Stock available for issuances from 593,340 to 1,648,213 shares. Effective January 1, 2022, an evergreen provision contained in the Company's 2021 Omnibus Equity Incentive Plan, or the 2021 Plan, added one percent of common shares outstanding as of December 31, 2021 to the 2021 Plan. This evergreen provision resulted in an increase of 83,286 shares to the 2021 Plan, increasing shares authorized for issuance under the 2021 Plan to 1,731,499 as of January 1, 2022. On June 29, 2021, the Company’s board of directors approved a 1-for-20.5 reverse split of all outstanding shares of common stock, effected on July 1, 2021 (no fractional shares were issued). Except as otherwise noted, all references to share and per share amounts related to common stock and common units have been restated to reflect the reverse stock split. On July 12, 2021, the Company’s board of directors amended its Certificate of Incorporation to further adjust the conversion price and certain conversion mechanics of the Company’s issued and outstanding Series 1d Preferred Stock. The two amendments to the Series 1d Preferred Stock conversion terms were combined for purposes of accounting for the amendments. In order to determine if these amendments resulted in a modification or extinguishment of the Series 1d Preferred Stock, pursuant to the related authoritative guidance, the Company engaged an independent third-party valuation firm to assist with determining the fair value of the Series 1d Preferred Stock immediately before the change in conversion terms, as well as immediately after the change in conversion terms. This resulted in a substantive increase in fair value, and as such, the Company determined the amendments resulted in extinguishment accounting. Accordingly, the Company applied ASC 260, Earnings per Share, and ASC 470, Debt, by analogy to determine the appropriate measurement and presentation. The Company compared the fair value of the Series 1d Preferred Stock, as amended, to its carrying value and recorded the resulting difference of approximately $2.3 million as a deemed dividend for the Series 1d preferred shareholders. The Company recorded the deemed dividend to additional paid-in capital during the quarter ended September 30, 2021. Because the Company is in an accumulated deficit position, the deemed dividend increased the net loss attributable to the common shareholders for the three and nine months ended September 30, 2021. 19 Table of Contents On July 30, 2021, the Company entered into a Second Amendment to the License and Settlement Agreement (or, the Second License Amendment), whereby, for the settlement of certain disputes arising under the License Agreement, the Company agreed to exchange the shares of Series 1c Preferred Stock owned by Villani, Inc. (“Villani”) for an increase of milestone payments and royalty rates due to Villani under the License Agreement. On July 30, 2021, Villani surrendered 5,221,156 shares of Series 1c Preferred Stock to the Company and on August 17, 2021, the Company paid to Villani $ 1.0 million upon the close of the Company’s initial public offering for the redemption of the Series 1c shares. The Company determined that the deemed dividend to Villani for the Series 1c preferred share redemption was the difference between the $1.0 million paid for the shares and the carrying value of the shares of $ 730,962 , resulting in a deemed dividend of $ 269,038 . This deemed dividend of $ 269,038 was recorded to additional paid-in capital during the quarter ended September 30, 2021. Because the Company is in an accumulated deficit position, the deemed dividend increased the net loss attributable to common shareholders for the three and nine months ended September 30, 2021. On August 14, 2021, the Company’s board of directors approved an amendment to the Company’s Certificate of Incorporation to increase the number of shares of Common Stock authorized to 90,000,000 . On July 11, 2022, the Company filed a Certificate of Amendment (the “Certificate of Amendment”) to the Company’s Amended and Restated Certificate of Incorporation (the “Certificate of Incorporation”) with the Secretary of State of the State of Delaware to increase the number of authorized shares of the Company’s common stock from 90,000,000 shares to 250,000,000 shares. The increase in the number of authorized shares was approved by the holders of a majority of the outstanding shares of common stock of the Company at its annual meeting on July 11, 2022. Warrants Warrants issued at IPO On August 17, 2021, the Company completed its IPO, in which it sold 2,571,428 shares of its common stock together with 2,571,428 warrants to purchase one share of common stock with an exercise price of $ 7.00 per share at a combined offering price of $ 7.00 . The underwriters exercised their option to purchase an additional 385,714 warrants with an exercise price of $ 7.00 , increasing the number of warrants issued at IPO to 2,957,142 . Each warrant is immediately exercisable at the option of the holder and expires five years from the date of issuance. The Company evaluated the terms of the warrants issued at the IPO and determined that they should be classified as equity instruments based upon accounting guidance provided in ASC 480, Distinguishing Liabilities from Equity, and ASC 815, Derivatives and Hedging. Since the Company determined that the warrants were equity classified, the Company recorded the proceeds from the IPO, net of issuance costs, within common stock at par value and the balance of proceeds to additional paid in capital. The fair value of each warrant on August 17, 2021 was $ 0.9995 based on the closing trading price on that day. As of September 30, 2022, the Company had 2,957,142 warrants outstanding resulting from the IPO with an exercise price of $ 7.00 and which expire August 17, 2026 . As of September 30, 2022, the outstanding warrants are exercisable into 2,957,142 shares of common stock whose fair value was $ 0.52 per share, based on the closing trading price on that day. 20 Table of Contents Underwriter IPO Warrants Upon the closing of the Company's IPO in August 2021, the Company issued to the underwriters warrants to purchase 128,571 of shares of common stock at an exercise price equal to 115 % of the public offering price, or $ 8.05 per share, exercisable for a period of five years, or until August 2026. As of September 30, 2022, the Company had 128,571 warrants outstanding resulting from the underwriter IPO warrants with an exercise price of $ 8.05 and which expire August 17, 2026 . As of September 30, 2022, the outstanding warrants are exercisable for 128,571 shares of common stock whose fair value was $ 0.52 per share, based on the closing trading price on that day. Warrants issued with Class B Common Units In March 2021, the Company granted Class B Common Units Profits interests to certain former employees and consultants. In connection with the conversion from an LLC to a C-Corporation, the Company converted 65,303 of vested Units to fully vested Common Stock Warrants with an exercise price of $ 5.74 . These Common Stock Warrants issuances were considered a modification under ASC 718, Stock Compensation, in which the fair value of the Class B Common Units profits interests were measured at the modification date and compared to the fair value of the common stock warrants, with the difference of $ 279,812 recorded as stock-based compensation expense in the first quarter of 2021. As of September 30, 2022, the Company had 65,303 common warrants outstanding related to the prior Class B Common Units with an exercise price of $ 5.74 and which expire December 31, 2024. As of September 30, 2022, the outstanding warrants are exercisable into 65,303 shares of common stock whose fair value was $ 0.52 per share, based on the closing trading price on that day. Warrants issued with Series 1a Preferred Units In connection with the issuance of 5,000,000 Series 1a Preferred Units in November 2016, each Series 1a Preferred Member received Warrant Units to purchase from the Company, at any time after November 15, 2016 and on or prior to November 15, 2021, such number of Series 1a Preferred Units as such Series 1a Preferred Member shall request, up to an aggregate number of Series 1a Preferred Units not to exceed the product of 25% and the aggregate number of Series 1a Preferred Units then held by such Series 1a Preferred Member, which was 1,231,250 units at December 31, 2020. The exercise price for each Warrant Unit was $1.00, subject to adjustment for unit splits and combinations. The warrants had a 5-year term. The Company received total proceeds of $ 5,000,000 for the Series 1a Preferred Units and warrants which were allocated on a relative fair value basis to the Units and warrants resulting in a relative fair value of $ 4,381,199 and $ 618,801 , respectively. The estimated fair value of the Series 1a Warrant Units was recorded as a separate component of members’ equity (deficit) in the accompanying financial statements as of December 31, 2020. In June 2020, 18,750 of the warrants were exercised for consideration of $ 18,750 , which consideration was received in July 2020. In connection with the Loan and Security Agreement, SVB also received Warrant Units to purchase, at any time after February 9, 2017 and prior to February 9, 2027, 187,978 Series 1a Preferred Units or the equivalent Series A Preferred Units had they purchased Series 1a Preferred Units, if Series A Preferred Units are issued, at an exercise price of $ 1.00 per unit. On March 24, 2021, in connection with the conversion from an LLC to a C-Corporation, each warrant to purchase Series 1a Preferred Units in the LLC was automatically converted into a warrant to purchase, upon the same terms and conditions, shares of Series 1a Preferred Stock of the Company. In July 2021, the Company effected a reverse split of shares of the Company’s common stock at a ratio of 1-for-20.5, and the conversion ratio of the preferred stock was adjusted accordingly. In August 2021, in connection with the Company’s IPO, the outstanding Series 1a preferred warrants were converted into 69,212 common warrants. As of September 30, 2022, the Company had 69,212 common warrants outstanding related to the prior Series 1a preferred warrants with an exercise price of $ 20.50 and which expire November 15, 2026. As of September 30, 2022, the outstanding warrants are exercisable into 69,212 shares of common stock whose fair value was $ 0.52 per share, based on the closing trading price on that day. 21 Table of Contents Common and Pre-Funded Warrants issued with PIPE In April 2022, the Company completed the PIPE, in which it sold 898,585 shares of its common stock together with 2,875,000 Pre-funded Warrants to purchase one share of common stock with an exercise price of $ 0.0001 per share, and 3,773,585 PIPE Common Warrants to purchase one share of common stock with an exercise price of $ 1.325 per share, at a combined offering price of $ 1.325 . Each PIPE Common Warrant is immediately exercisable at the option of the holder and expires May 13, 2027. During the quarter ended June 30, 2022, 875,000 of the Pre-funded Warrants were exercised. During the quarter ended September 30, 2022, the remaining 2,000,000 Pre-funded Warrants were exercised. No additional Pre-funded Warrants are outstanding as of September 30, 2022. As of September 30, 2022, the Company had 3,773,585 PIPE Common Warrants outstanding with an exercise price of $ 1.325 and which expire May 13, 2027. As of September 30, 2022, the outstanding PIPE Common Warrants are exercisable into 3,773,585 shares of common stock whose fair value was $ 0.52 per share, based on the closing trading price on that day. 7. Equity Incentive Plan Under the Company’s 2021 Omnibus Equity Incentive Plan (the “2021 Plan”), the Company may grant options to purchase common stock, restricted stock awards, performance stock awards, incentive bonus awards, other cash-based awards or directly issue shares of common stock to employees, directors, and consultants of the Company. Effective January 1, 2022, an evergreen provision contained in the Company’s 2021 Plan increased the total number of shares of common shares issuable under the 2021 Plan in an amount equal to one percent of the Company’s common shares outstanding as of December 31, 2021. This evergreen provision resulted in an additional 83,286 common shares issuable pursuant to the 2021 Plan, increasing the total authorized shares available for issuance under the 2021 Plan to 1,731,499 as of January 1, 2022. Stock awards may be granted at an exercise price per share of not less than 100 % of the fair market value at the date of grant. Stock awards granted are exercisable over a maximum term of 10 years from the date of grant and generally vest over a period of four years for employees and one year for directors of the Company’s board and consultants . As of September 30, 2022, there remain an additional 547,447 shares reserved for issuance under the 2021 Plan. Fair Value Measurement The Company uses the Black-Scholes option valuation model, which requires the use of highly subjective assumptions, to determine the fair value of stock-based awards. The fair value of each employee stock option is estimated on the grant date under the fair value method using the Black-Scholes model. The estimated fair value of each stock option is then expensed over the requisite service period, which is generally the vesting period. The assumptions and estimates that the Company uses in the Black-Scholes model are as follows: · Fair Value of Common Stock. The estimated fair value of the common stock underlying the Company’s stock option plan was determined by management by considering various factors as discussed below. All options to purchase shares of the Company’s common stock are intended to be exercisable at a price per share not less than the per-share fair value of the Company’s common stock underlying those options on the date of grant. In the absence of a public trading market for the Company’s common stock, before the initial public offering, on each grant date, the Company developed an estimate of the fair value of its common stock based on the information known to the Company on the date of grant, upon a review of any recent events and their potential impact on the estimated fair value per share of the common stock and in part on input from an independent third-party valuation firm. After the Company’s initial public offering, the fair value of common stock is measured as the Company’s closing price of common stock on the date of grant. · Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to that of the expected term of the options. · Expected Term. The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. Because of the limitations on the sale or transfer of the Company’s common stock as a privately held company, the Company does not believe its historical exercise pattern is indicative of the pattern it will experience as a publicly traded company. The Company plans to continue to use the SAB 110 simplified method until it has sufficient trading history as a publicly traded company. 22 Table of Contents · Volatility. The Company determines the price volatility based on the historical volatilities of industry peers as it has limited trading history for its common stock price. Industry peers consist of several public companies in the biotechnology industry with comparable characteristics, including clinical trials progress and therapeutic indications. · Dividend Yield. The expected dividend assumption is based on the Company’s current expectations about its anticipated dividend policy. To date, the Company has not declared any dividends to common shareholders, and therefore the Company has used an expected dividend yield of zero. The following table presents the weighted-average assumptions used for the stock option grants: Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Grant date fair value $ 0.45 $ 4.54 $ 1.46 $ 4.87 Risk-free rate 2.9 % 0.98 % 1.5 % 0.92 % Dividend yield 0.00 % 0.00 % 0.0 % 0.00 % Expected life in years 6.1 5.8 5.4 5.7 Expected volatility 132 % 125 % 123 % 122 % Stock-based Compensation Expense In general, stock-based compensation is allocated to research and development expense or general and administrative expense according to the classification of cash compensation paid to the employee, director, or consultant to whom the stock award was granted. On March 24, 2021, in connection with the conversion from an LLC to a C-Corporation, the Company converted 277,448 of Class B Common Units profits interests, for which no consideration had been received, into 277,448 options to purchase common stock at an exercise price of $ 5.74 to $ 6.314 per share. The fair value of common stock prior to IPO was determined in part based upon input from an independent third-party valuation firm. The Company considered the conversion of these Class B Common Units profits interests as a modification under ASC 718, Stock Compensation, in which the fair value of the Class B Common Units profits interests was measured at the modification date and compared to the fair value of the common stock options, with the difference of $ 1,339,993 resulting in incremental stock-based compensation expense. Related to the options, the Company recorded $ 849,564 of stock-based compensation expense recorded in the first quarter of 2021. In December 2021, the Company’s board of directors authorized a stock option grant in lieu of a cash bonus for the Company’s Chairman and Chief Executive Officer. The stock-based compensation expense of $ 0.4 million related to the stock option grant was booked to the fiscal year ended December 31, 2021; however, the impact to additional paid-in capital was not booked until the first quarter of 2022, when the stock option award was granted. 23 Table of Contents The following table summarizes the total stock-based compensation expense related to stock options and RSUs included in the Company’s statements of operations: Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Research and development $ 54,907 $ 30,075 $ 163,417 $ 310,046 General and administrative 180,076 112,580 546,018 1,106,645 $ 234,983 $ 142,655 $ 709,435 $ 1,416,691 Stock Option Award Activity A summary of the Company’s Equity Plan stock option activity is as follows: Number of Options Outstanding Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (in Years) Balance at December 31, 2021 523,199 $ 5.84 8.8 Options granted 533,127 1.75 - Options exercised - - - Options cancelled - - - Balance at September 30, 2022 1,056,326 $ 3.77 8.5 Options exercisable at September 30, 2022 586,100 $ 4.32 8.6 The aggregate intrinsic value of options exercisable as of September 30, 2022 is calculated as the difference between the exercise price of the underlying options and the closing market price of the Company’s common stock on that date, which was $ 0.52 per share. The intrinsic value of options outstanding and exercisable as of September 30, 2022 was $ 385 . As of September 30, 2022, total unrecognized compensation cost related to stock options was approximately $ 1.1 million and the weighted average period over which this cost is expected to be recognized is 2.5 years. Restricted Stock Unit Award Activity A summary of the Company’s Equity Plan restricted stock unit, or RSU, award activity is as follows: Number of RSU’s outstanding Balance at December 31, 2021 - RSUs granted 127,726 RSUs settled - RSUs cancelled - Balance at September 30, 2022 127,726 During the three and nine months ended September 30, 2022, the Company issued to certain of the Company’s directors 80,589 and 127,726 RSUs, respectively, as partial compensation for their services during 2022. The Company recognized stock-based compensation expense of approximately $ 0.1 million during the three and nine months ended September 30, 2022 related to the restricted stock unit awards. There were no RSUs outstanding during 2021 and there is no unrecognized compensation expense related to outstanding RSUs as of September 30, 2022. 24 Table of Contents 8. 401(k) Plan The Company sponsors a 401(k) savings plan for all eligible employees. The Company may make discretionary matching contributions to the plan to be allocated to employee accounts based upon employee deferrals and compensation. To date, the Company has not made any matching contributions into the savings plan. 9. License Agreements On March 31, 2017, the Company entered into a license agreement, as amended (the “License Agreement”) with Villani, Inc. whereby Villani has granted the Company an exclusive, sub-licensable, royalty-bearing license (the “License”) under the Licensed Patents (as defined in the License Agreement), to formulate, develop, seek regulatory approval for, make or sell products that contain Spongilla lacustris (alone or in combination with other active or inactive ingredients) for the treatment of diseases, disorders and conditions of the skin, including but not limited to acne, rosacea, psoriasis, atopic dermatitis, seborrheic dermatitis, actinic keratosis and eczema that were developed using certain licensed know-how (“Licensed Products”). The Company is responsible for the development (including manufacturing, packaging, non-clinical studies, clinical trials and obtaining regulatory approval and commercialization (including marketing, promotion, distribution, etc.)) for all Licensed Products. In partial consideration of the License, the Company forgave its previous outstanding loan to Villani in the amount of $ 400,000 . The original License Agreement was amended in 2019 and, in consideration of the receipt of certain know-how and patents, the Company issued to Villani 5,221,156 Series 1c Preferred Units equal to 5 % of the Company’s fully diluted capitalization, valued at $ 730,962 . Pursuant to the amended License Agreement, the Company was required to make future milestone payments to Villani in an aggregate amount of up to $ 20.25 million upon the achievement of specified development and sales milestones, payable in cash or in equity, at the option of Villani, as well as single-digit royalty payments on net sales. On July 30, 2021, the Company further amended the License Agreement in the Second Amendment to the License and Settlement Agreement (the “Second Amendment”). In consideration of the Second Amendment, Villani exchanged the 5,221,156 Series 1c Preferred Shares issued to Villani in 2019 for an increase in milestone payments and royalty rates payable pursuant to the License Agreement and the Company paid Villani $ 1 million after the close of the IPO. Pursuant to the Second Amendment, the Company is required to make future milestone payments to Villani in an aggregate amount of up to $ 40.5 million upon the achievement of specified development and sales milestones, payable in cash or in equity, at the option of Villani, as well as single-digit royalty payments on net sales. The Second Amendment includes customary terms relating to, among others, indemnification, intellectual property protection, confidentiality, remedies, and warranties. See Note 6 – Equity Securities for additional information regarding the Company’s redemption of the Series 1c Preferred Shares from Villani. 10. Commitments and Contingencies Clinical Trials During 2021, the Company initiated a clinical trial which completed patient enrollment in June 2022; however, the Company had not completed data analysis for the clinical trial by September 30, 2022. Accordingly, the Company anticipates additional research and development expense of $ 0.1 to $ 0.2 million to be incurred during the fourth quarter of fiscal year 2022 related to this ongoing clinical trial. Coronavirus Pandemic On March 11, 2020, the World Health Organization declared the outbreak of a coronavirus (COVID-19) pandemic. Significant uncertainties may arise with respect to potential shutdowns of operations or government orders to cease activities due to emergency declarations, inability to operate, employee shortages, or claims for business interruption insurance, etc. Each of these matters may have a significant impact on the future results of the Company. 25 Table of Contents Supplier Agreement As a result of Russia’s invasion of Ukraine, the United States, the United Kingdom, and the European Union governments, among others, have developed coordinated sanctions and export-control measure packages against Russian individuals and entities. The Company is currently a party to an exclusive supply agreement for the supply of the Spongilla raw material used in DMT310 and DMT410. The counterparty to this supply agreement is a Russian entity. The imposition of enhanced export controls and economic sanctions on transactions with Russia and Russian entities by the United States, the United Kingdom, and/or the European Union could prevent the Company from performing under this existing contract or any future contract it may enter or may prevent the Company from remitting payment for raw material purchased from the Company’s supplier. The Company has received two shipments of raw material from its supplier during fiscal year 2022 containing additional quantities of Spongilla raw material which will provide the Company with sufficient quantities of Spongilla to initiate and complete two Phase 3 studies in moderate-to-severe acne and support filing a new drug application for DMT310 in acne upon the successful completion of two Phase 3 studies. Depending on the extent and breadth of new sanctions or export controls that may be imposed against Russia, otherwise or as a result of the impact of the war in Ukraine, it is possible that the Company’s ability to obtain additional supply of the Spongilla raw material used in DMT310 and DMT410 could be negatively impacted, which could adversely affect its business, results of operations, and financial condition. Legal Proceedings In the normal course of business, the Company may be involved in legal proceedings or threatened legal proceedings. The Company is not a party to any legal proceedings or aware of any threatened legal proceedings which are expected to have a material adverse effect on its financial condition, results of operations or liquidity. 11. Related Parties Prior to the Company converting from an LLC to a C-corporation in March 2021, the Company had two Managing Members. One of the Managing Members remained the Company’s majority stockholder upon the close of the Company’s IPO and serves as the Company’s President, Chief Executive Officer, and Chairman of the Board of Directors. The other Managing Member remained a beneficial owner upon the close of the Company’s IPO and serves as the Company’s Lead Director of the Board of Directors. Hereinafter these two Managing Members, and their affiliates, are referred to collectively as the Principal Stockholders after the completion of the IPO. During 2020, the Managing Members and other related parties loaned the Company $ 1,145,000 as subordinated convertible promissory notes. Additionally, during the first quarter of 2021, the Managing Members and other related parties loaned the Company $ 1,255,000 as subordinated convertible promissory notes. Refer to Note 4 – Subordinated Convertible Promissory Notes for further discussion. During the third quarter of 2021, the Company amended the conversion terms of its Series 1d preferred stock, as described in Note 6 – Equity Securities. As a result of the Series 1d preferred stock amendments, the Company presented a deemed dividend of approximately $ 2.3 million for the year ended December 31, 2021, approximately $ 1.2 million of which related to Series 1d preferred shares owned by the Company’s Principal Stockholders and their affiliates. 26 Table of Contents