Fair Value Measurements

6 Months Ended

Jun. 30, 2022

3. Fair Value Measurements

The following table summarizes the fair value of the Company’s financial liabilities measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):


	June 30, 2022
	Level 1		Level 2		Level 3		Total
Liabilities:
Common stock warrant liabilities	$	—	$	—	$	711	$	711
Derivative liability - Deferred royalty obligation		—		—		1,600		1,600
Derivative liability - Oaktree term loan		—		—		863		863
Total financial liabilities	$	—	$	—	$	3,174	$	3,174


	December 31, 2021
	Level 1		Level 2		Level 3		Total
Liabilities:
Common stock warrant liabilities	$	—	$	—	$	637	$	637
Total financial liabilities	$	—	$	—	$	637	$	637

The following table summarizes the change in the fair value of the common stock warrant liabilities for the six months ended June 30, 2022 (in thousands):


Beginning balance as of December 31, 2021	$	637
Changes in fair value		74
Ending balance as of June 30, 2022	$	711

The following table summarizes the change in the estimated fair value of the Company’s derivative liabilities for the six months ended June 30, 2022 (in thousands):


Beginning balance as of December 31, 2021	$	—
Initial fair value of derivative liability - Deferred royalty obligation		1,500
Initial fair value of derivative liability - Oaktree term loan		405
Change in fair value of derivatives		558
Ending balance as of June 30, 2022	$	2,463

Fair values of the Company’s common stock warrants and the embedded derivative liability are based on significant inputs not observed in the market, and thus represent a Level 3 measurement.

Pursuant to the loan and security agreement with Oxford Finance LLC and Silicon Valley Bank, the Company issued common stock warrants (see Note 7). The Company's warrants are not indexed to the Company’s common stock in the manner contemplated by ASC 815-40 because the warrant provides for an adjustment to the exercise price upon an acquisition. The Warrants were measured at fair value at inception and are subsequently remeasured at each reporting date with changes in fair value recognized as a component of other income (expense), net in the condensed consolidated statement of operations and other comprehensive loss. The Company determined the fair value of the common stock warrants using the following assumptions as of June 30, 2022 using the Black-Scholes-Merton option pricing model based on significant unobservable inputs. The significant unobservable inputs used in the fair value measurement of the warrant liabilities were the volatility rate and the estimated term of the warrants. Assumptions used included an expected term of 10 years, stock volatility of 81% and risk-free interest rate of 3.0% during the six months ended June 30, 2022.

The senior secured loan agreement and related security agreement with Oaktree Fund Administration, LLC, or the Oaktree Loan and Security Agreement (see Note 7), contains embedded derivatives requiring bifurcation as a derivative instrument. The fair value of the embedded derivative liabilities associated with the term loans was estimated using a probability weighted discounted cash flow model to measure the fair value. This involves significant Level 3 inputs and assumptions including an (i) estimated probability and timing of a change in control (ii) our risk-adjusted discount rate.

The embedded derivative liability associated with our deferred royalty obligation (see Note 7) is measured at fair value using an option pricing Monte Carlo simulation model and is included as a component of the deferred royalty obligation. The embedded derivative liability is subject to remeasurement at the end of each reporting period, with changes in fair value recognized as a component of other expense, net. The assumptions used in the option pricing Monte Carlo simulation model include: (i) our estimates of the probability and timing of related events; (ii) the probability-weighted net sales of Trudhesa; (iii) our risk-adjusted discount rate; (iv) our cost of debt; and (v) the probability of a change in control occurring during the term of the instrument.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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