NOTE 6 — STOCKHOLDERS’ DEFICIT

Private placement — On September 11, 2013, the Company issued an aggregate of 3,020,501 units at a price of $2.50 per unit (the “Private Placement”). Each unit consisted of one share of common stock and one common stock warrant for the purchase of an additional share of common stock. The aggregate purchase price for the units was $7,551,253. In addition, 300,000 warrants for the purchase of a share of common stock were issued to a broker under the same terms as the Private Placement transaction (the “Broker Warrants”).

The warrants issued in the Private Placement and the Broker Warrants entitle the holders thereof to purchase, at any time on or prior to September 11, 2018, shares of common stock of the Company at an exercise price of $3.50 per share. The warrants contain non-standard anti-dilution protection and, consequently, are being accounted for as liabilities, were originally recorded at fair value, and are adjusted to fair market value each reporting period. Because the shares of common stock underlying the Private Placement warrants and Broker Warrants were not effectively registered for resale by September 11, 2014, the warrant holders have an option to exercise the warrants using a cashless exercise feature. The shares have not been registered for resale as of June 30, 2016. The availability to warrant holders of the cashless exercise feature as of September 11, 2014 caused the then-outstanding 2,225,036 Private Placement warrants and Broker Warrants with fair value of $7,068,000 to be reclassified from liability classified warrants to warrant derivative liabilities and to continue to be remeasured at fair value each reporting period. On June 10, 2014, certain warrant holders exercised 1,095,465 warrants issued in the Private Placement for the exercise price of $3.50 per share, resulting in the Company receiving aggregate exercise proceeds of $3.8 million and issuing 1,095,465 shares of common stock. Prior to exercise, these Private Placement warrants were accounted for at fair value as liability classified warrants. As of June 10, 2014, immediately prior to exercise, the carrying value of these Private Placement warrants was reduced to their fair value immediately prior to exercise of $1.8 million, representing their intrinsic value, with this adjusted carrying value of $1.8 million being transferred to additional paid-in capital. Also on June 10, 2014, based on an offer made to holders of Private Placement warrants in connection with such exercises, the Company issued an aggregate of 1,095,465 replacement warrants to holders exercising Private Placement warrants, which replacement warrants have terms that are generally the same as the exercised warrants, including an expiration date of September 11, 2018 and an exercise price of $3.50 per share. The replacement warrants are treated for accounting purposes as liability classified warrants, and their issuance gave rise to a $3.5 million warrant exercise inducement expense based on their fair value as of issuance as determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model. Because the shares of common stock underlying the replacement warrants were not effectively registered for resale by June 10, 2015, the warrant holders have an option to exercise the warrants using a cashless exercise feature. The shares have not been registered for resale as of June 30, 2016. The availability to warrant holders of the cashless exercise feature as of June 10, 2015 caused the then-outstanding 1,095,465 replacement warrants with fair value of $2,545,000 to be reclassified from liability classified warrants to warrant derivative liabilities and to continue to be remeasured at fair value each reporting period.

In connection with the secured loans disclosed in Note 5 for $1,295,000 in April and May 2016, the Company issued the lender warrants for the purchase of 62,500 shares of its common stock at an exercise price of the lowest of the fair market value of its common stock during the quarter ended June 30, 2016 or the lowest public sale price of its common stock during the quarter ended June 30, 2016. These warrants, at issuance dates of April and May 2016, contain variable settlement provisions since the exercise price of these warrants is unknown. As a result, these warrants are initially accounted for as derivative liabilities recorded at fair value as determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model with the adjustment in its fair value charged against earnings through June 30, 2016. As of June 30, 2016, the settlement provision is no longer variable since the exercise price becomes fixed and as a result, the warrants are reclassified to equity as it no longer meets the definition of a liability and/or a derivative liability. The following table illustrates the initial fair value of these warrants on April and May 2016 as well as the fair value of the warrants as of June 30, 2016 as determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model:

	April 2016		May 2016		June 30, 2016		Charge Against Earnings
April 2016 Warrant	$	251,971	$	—	$	260,400	$	8,429
May 2016 Warrant	—		64,639		65,100		461
Total	$	251,971	$	64,639	$	325,500	$	8,890

As of June 30, 2016, the fair value of these Private Placement warrants, replacement warrants, and Broker Warrants was $7,911,000 (see Note 2). For further details regarding registration rights associated with the Private Placement warrants, replacement warrants and Broker Warrants, see the Registration Rights section below in this footnote.

A summary of outstanding warrants as of June 30, 2016 and December 31, 2015 is presented below.

	Six months ended June 30, 2016	Year ended December 31, 2015
Warrants outstanding, beginning of period	3,530,918	5,101,450
Granted	175,000	110,417
Exercised	—	(148,256	)
Cancelled, forfeited or expired	—	(1,532,693	)
Warrants outstanding, end of period	3,705,918	3,530,918

A summary of outstanding warrants by year issued and exercise price as of June 30, 2016 is presented below.

			Outstanding				Exercisable
Exercise Price			Number of Warrants Issued	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Total	Weighted Average Exercise Price
At December 31, 2013
	$	3.30	50,000	1.84	$	3.30	50,000	$	3.30
	$	3.50	2,225,036	2.20	$	3.50	2,225,036	$	3.50
	2013 total		2,275,036				2,275,036

At December 31, 2014
	$	3.50	1,145,465	2.23	$	3.50	1,145,465	$	3.50
	2014 total		1,145,465				1,145,465

At December 31, 2015
	$	4.90	110,417	3.68	$	4.90	110,417	$	4.90
	2015 total		110,417				110,417
During 2016
	$	4.50	100,000	5.00	$	4.50	100,000	$	4.50
	$	4.70	75,000	4.84	$	4.70	75,000	$	4.70
	Total		3,705,918				3,705,918

Stock options — During the six months ended June 30, 2016, the Company’s Board of Directors granted 2,596,200 options to its officers, directors and employees. Of these options, 300,000 will equally vest one-third on each of the first three anniversaries of the grant date, have an exercise price of $4.70 per share and are exercisable through 2026, 2,296,200 options will vest over three years starting May 10, 2017, have an exercise price of $5.00 per share and are exercisable through 2026. During the year ended December 31, 2015, no options were granted by the Company’s Board of Directors. As of June 30, 2016, there were 7,262,201 options outstanding under the Emmaus Life Sciences, Inc. 2011 Stock Incentive Plan.

A summary of outstanding options as of June 30, 2016 is presented below.

	June 30, 2016				December 31, 2015
	Number of Options		Weighted- Average Exercise Price		Number of Options		Weighted- Average Exercise Price
Options outstanding, beginning of period	4,753,335		$	3.60	5,669,000		$	3.68
Granted or deemed issued	2,596,200		$	4.94	—		$	—
Exercised	(1,866	)	—		(2,000	)	$	3.60
Cancelled, forfeited and expired	(85,468	)	$	4.88	(913,665	)	$	4.05
Options outstanding, end of period	7,262,201		$	4.07	4,753,335		$	3.60
Options exercisable, end of period	4,640,668		$	3.59	4,379,335		$	3.60
Options available for future grant, end of period	1,737,799				4,246,665

During the six months ended June 30, 2016 and 2015, the Company recognized $1.0 million and $2.2 million, respectively, of share-based compensation cost arising from stock options. As of June 30, 2016, there was $7.3 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the 2011 Stock Incentive Plan. That cost is expected to be recognized over the weighted average remaining period of 2.8 years.

Registration rights — Pursuant to the Subscription Agreements relating to the Private Placement and certain warrants, as well as pursuant to the replacement of certain warrants by the Company on June 10, 2014, the Company agreed to use its commercially reasonable best efforts to have on file with the SEC, by September 11, 2014 and at the Company’s sole expense, a registration statement to permit the public resale of 4,115,966 shares of the Company’s common stock and 3,320,501 shares of common stock underlying warrants (collectively, the “Registrable Securities”). In the event such registration statement includes securities to be offered and sold by the Company in a fully underwritten primary public offering pursuant to an effective registration under the Securities Act, and the Company is advised in good faith by any managing underwriter of securities being offered pursuant to such registration statement that the number of Registrable Securities proposed to be sold in such offering is greater than the number of such securities which can be included in such offering without materially adversely affecting such offering, the Company will include in such registration the following securities in the following order of priority: (i) any securities the Company proposes to sell, and (ii) the Registrable Securities, with any reductions in the number of Registrable Securities actually included in such registration to be allocated on a pro rata basis among the holders thereof. The registration rights described above apply until all Registrable Securities have been sold pursuant to Rule 144 under the Securities Act or may be sold without registration in reliance on Rule 144 under the Securities Act without limitation as to volume and without the requirement of any notice filing.

If the shares of common stock underlying these warrants to purchase 3,320,501 shares are not registered for resale at the time of exercise, and the registration rights described above then apply with respect to the holder of such warrants, such holder may exercise such warrants on a cashless basis. In such a cashless exercise of all the shares covered by the warrant, the warrant holder would receive a number of shares equal to the quotient of (i) the difference between the fair market value of the common stock, as defined, and the $3.50 exercise price, as adjusted, multiplied by the number of shares exercisable under the warrant, divided by (ii) the fair market value of the common stock, as defined. As of June 30, 2016, based on a fair market value of a share of the Company’s common stock of $5.00 and 3,320,501 warrants issued and outstanding and eligible for cashless exercise, the maximum number of shares the Company would be required to issue, if the warrant holders elected to exercise the cashless exercise feature with respect to all then eligible warrants, is 996,150 shares. If the fair market value of a share of the Company’s common stock were to increase by $1.00 from $5.00 to $6.00, the maximum number of shares the Company would be required to issue, if the warrant holders elected to exercise the cashless exercise feature with respect to all then eligible warrants, would increase to 1,383,542 shares as of June 30, 2016.

The Company has not yet filed a registration statement with respect to the resale of the Registrable Securities because doing so is not feasible prior to the completion by the Company of its initial public offering. As previously reported, the Company has filed a draft registration statement with the SEC with respect to its proposed initial public offering. The Company believes that it has used commercially reasonable efforts to pursue an initial public offering and, accordingly, considers itself to be in compliance with its registration rights obligations notwithstanding that it has not filed a registration statement with respect to the resale of the Registrable Securities and the deadline for doing so has passed without extension.