10.

Derivative Financial Instruments

The Company determined that certain embedded features related to the Series 1 preferred stock are derivative financial instruments. The company values the embedded derivative financial instruments related to the Series 1 preferred stock as Level 3 financial liabilities (Note 3).

Fair values of derivative instruments to be classified as derivative liabilities on the balance sheet consist of the following:


($ in thousands)
Liability derivatives:	Balance Sheet Location		Fair Value
December 31, 2017:
Derivative liabilities		Liabilities	$	2,424

The change in the derivative liability for the year ended December 31, 2017 and 2016 consists of the following:


($ in thousands)
	Fair Value
Balance, June 30, 2016	$	694
Dividends		44
Change in fair value		124

Balance, December 31, 2016	$	862
Dividends		267
Change in fair value		1,295

Balance, December 31, 2017	$	2,424

The fair value of the Series 1 preferred stock dividends was estimated using a probability-weighted approach and a Monte Carlo simulation model. The fair value of the embedded derivatives was estimated using the “with” and “without” method where the preferred stock was first valued with all of its features (“with” scenario) and then without derivatives subject to the valuation analysis (“without” scenario). The fair value of the derivatives was then estimated as the difference between the fair value of the preferred stock in the “with” scenario and the preferred stock in the “without” scenario. The model also takes into account, management estimates of clinical success/failure based upon market studies and probability of potential conversion and liquidation events. If these estimates were different, the valuations would change, and that change could be material. Inputs to the models included the following:


	December 31,
	2017	2016
Risk-free interest rate	1.92 - 2.12%	1.04% - 1.69%
Expected dividend rate	0	0
Expected volatility	68.7 - 80.4%	70.5% - 72.70%
Preferred stock conversion limit—percentage of outstanding common stock	19.90%	19.90%
Preferred conversion floor price	$1.00	$1.00

See Notes 3 and 7 for additional discussion regarding the accounting for and valuation of these derivative financial instruments.