4. Fair Value Measurements

ASC 820 "Fair Value Measurements," defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1—Observable inputs such as quoted prices (unadjusted) for identical instruments in active markets.

Level 2—Observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or model‑derived valuations whose significant inputs are observable.

Level 3—Unobservable inputs that reflect the reporting entity’s own assumptions.

The following tables set forth the fair value of the Company’s consolidated financial instruments that were measured at fair value on a recurring basis as of December 31, 2018 and 2017:


	December 31, 2018
	Level 1		Level 2		Level 3		Total
Warrant liability	$	—	$	—	$	220,376	$	220,376
Derivative liability		—		—		—		—
Conversion option liability		—		—		—		—
Total fair value	$	—	$	—	$	220,376	$	220,376


	December 31, 2017
	Level 1		Level 2		Level 3		Total
Warrant liability	$	—	$	—	$	103,860	$	103,860
Derivative liability		—		—		11,000		11,000
Conversion option liability		—		—		111,841		111,841
Total fair value	$	—	$	—	$	226,701	$	226,701

The change in the estimated fair value of Level 3 liabilities is summarized below:


	For the year ended
	December 31, 2018
	Warrant		Derivative		Conversion Option
	Liability		Liability		Liability
Beginning value of Level 3 liability	$	103,860	$	11,000	$	111,841
Additions		611,286		—		—
Extinguishment		—		—		(286,595)
Change in fair value		(494,770)		(11,000)		174,754
Ending fair value of Level 3 liability	$	220,376	$	—	$	—

Warrant Liability

The warrants associated with the Level 3 warrant liability were the November 2016 Series A Warrants and the October 2018 Underwriter Warrants, which at December 31, 2018 were valued at $7,388 and $212,988, respectively in the Company’s consolidated balance sheet.

The Series A warrant valuation of $103,860 at December 31, 2017 was computed using the Black-Scholes-Merton pricing model using a stock price of $0.14, a strike price of $11.25 per share, an expected term of 4.41 years, volatility of 96.36% and a risk-free discount rate of 2.14%. The Series A warrant valuation of $7,388 at December 31, 2018 was computed using the Black-Scholes-Merton pricing model using a stock price of $0.23, a strike price of $11.25 per share, an expected term of 3.41 years, volatility of 135.63% and a risk-free discount rate of 2.46%. The net change in the fair value of the warrants of $96,472 for the year-ended December 31, 2018 is recorded in the change in fair value of warrants, derivative liability and conversion option liability in the consolidated statements of operations

The October 2018 Underwriter Warrants valuation of $611,286 issued in October 2018 was computed using the Black-Scholes-Merton pricing model using a stock price of $0.59, a strike price of $0.75 per share, an expected term of 5.0 years, volatility of 137.87% and a risk-free discount rate of 2.51%. The October 2018 Underwriter Warrants valuation of $212,988 at December 31, 2018 was computed using the Black-Scholes-Merton pricing model using a stock price of $0.23, a strike price of $0.75 per share, an expected term of 4.76 years, volatility of 135.63% and a risk-free discount rate of 2.51%. The net change in the fair value of the warrants of $398,298 for the year-ended December 31, 2018 is recorded in the change in fair value of warrants, derivative liability and conversion option liability in the consolidated statements of operations

Derivative Liability

The derivative liability associated with the Level 3 liability was associated with the June 2017 issuance of a convertible note payable (see Note 8). The Company computed fair values at the date of issuance of $15,000 and $5,000 for the repayment and the interest rate increase feature, respectively, using the Binomial Lattice Model, which was based on the generalized binomial option pricing formula. The derivatives were revalued again at September 30, 2018 using the same Model resulting in a combined minimal fair value. The resulting $11,000 gain for the year-ended December 31, 2018 is recorded in the change in fair value of warrants, derivative liability and conversion option liability in the consolidated statements of operations

Conversion Option Liability

In March 2017, Napo entered into an exchangeable note purchase agreement with two lenders for the funding of face amount of $1,312,500 in two $525,000 tranches of face amount $656,250. The Company assumed the notes at fair value of $1,312,500 as part of the Napo Merger. In December 2017, Napo amended the exchangeable note purchase agreement to extend the maturity of the first tranche and second tranche of notes to February 15, 2018 and April 1, 2018, respectively, increase the principal amount by 12%, and reduce the conversion price from $0.56 per share to $0.20 per share. The Company also issued 166,139 shares of common stock to the lenders in connection with this amendment to partially redeem $299,050 from the first tranche of the notes. The optional conversion option in the notes was bifurcated and accounted as a derivative liability at its fair value of $111,841 using the Black-Scholes-Merton model and the following criteria: stock price of $0.14 per share, conversion prices of $0.20 per share, expected life of 0.13 to 0.25 years, volatility of 86.29% to 160.78%, risk free rate of 1.28% to 1.39% and dividend rate of 0%. The $111,841 was included in conversion option liability on the balance sheet and in loss on extinguishment of debt on the statements of operations. The fair value of the conversion option liability was again revalued at March 23, 2018 using the Black-Scholes-Merton model using the following criteria: stock price of $0.21 per share, expected life of 0.11 years, volatility of 288.16%, risk free rate of 1.69% and dividend rate of 0%, resulting in an increase of $174,754 to the fair value of the conversion option liability. The underlying debt was paid off in March of 2018 and the $286,595 conversion option liability was written off to other income, net in the statements of operations.