Convertible Notes

2016 Private Placement

In September 2016, the Company issued an aggregate of $18,087,500 in principal of convertible promissory notes (each, a Note and collectively, the Notes) and accompanying warrants to purchase an aggregate of 1,205,840 shares of common stock (each a Warrant and collectively, the Warrants) in a private placement (the 2016 Private Placement) to institutional and accredited investors (each an Investor and collectively, the Investors).

The Notes bear interest at four percent (4%) per annum. Interest is earned daily and compounded quarterly and, at the election of the Company at the beginning of each quarter, shall accrue or be paid in cash. If the Company elects to have interest accrue, such interest will not be added to the principal amount of the Notes but such interest shall be subject to additional interest at the rate of four percent (4%) per annum, compounded quarterly, and shall be due and payable upon the earliest of the conversion of the Notes, exercise of the Put Right, exercise of the Prepayment Right or the Maturity Date (in each case, as defined below). Additionally, if the Company elects for interest to accrue, then (i) the Company may elect to repay any such accrued and unpaid interest in cash at any time and from time to time and (ii) each Investor may elect to have the Company repay any such accrued and unpaid interest by delivering such number of shares of common stock equal to (x) the amount of the accrued and unpaid interest to be repaid, divided by (y) the greater of (i) the last closing bid price of a share of the Company’s common stock as reported on Nasdaq on the date of such election and (ii) the Conversion Price (as defined below). As of December 31, 2018, the Company has elected to accrue interest.

All unpaid principal of each Investor’s Note is convertible, at any time and from time to time, at the option of such Investor into shares of common stock at a range of $17.04375 to $18.39375 (the “conversion price”), and any unpaid interest at the greater of (x) the conversion price and (y) the last closing bid price of a share of common stock as reported on Nasdaq at the time of such Investor’s execution of the Agreement for the Purchase and Sale of Convertible Debt and Common Stock Warrants plus $0.12625.

The Notes have a maturity date of the earlier of (i) September 7, 2026 and (ii) one-hundred and eighty (180) days after the date on which the Company’s product candidate, FCX-007, is approved by the United States Food and Drug Administration for the treatment of recessive dystrophic epidermolysis bullosa (the Maturity Date). Each Investor has the right to require the Company to repay all or any portion of the unpaid principal and accrued and unpaid interest from time to time on or after September 7, 2021 (such right, a Put Right). Such Put Right must be exercised by such Investor by delivering written notice to the Company no later than one-hundred and eighty (180) days prior to such exercise date of such Put Right. In addition, upon consummation of a specified change of control transaction, each Investor may elect to accelerate the repayment of all unpaid principal and accrued interest under such Investor’s Note. If an Investor does not elect to have the Company prepay its Note upon such change of control transaction, then the Company may prepay the Notes, in an amount equal to one hundred one percent (101%) of the outstanding principal due under the Notes (together with accrued and unpaid interest due thereon) (the Prepayment Right). Additionally, upon the occurrence of certain Events of Default, as defined in the Notes, each Investor may elect to accelerate the repayment of all unpaid principal and accrued interest under each Note and the Notes provide for automatic redemption upon the occurrence of certain bankruptcy related Events of Default, as defined in the Notes.

Accounting for Convertible Notes and Embedded Derivatives

The Company accounts for debt as liabilities measured at amortized cost and amortizes the resulting debt discount from allocation of proceeds to interest expense using the effective interest method over the expected term of the Notes pursuant to ASC 835, Interest (ASC 835).

See Note 3 for discussion of the Company’s policies for accounting for debt with detachable warrants. In connection with the issuance of the Notes and Warrants, the Company recorded a debt discount of approximately $18.1 million based on an allocation of proceeds to the Warrants of approximately $9.6 million, an allocation to bifurcated derivatives (which consist of a contingent put option upon a change of control or acceleration upon event of default (the Contingent Put Option) and a contingent call option upon a change of control (the Contingent Call Option) included in the Notes) of approximately $1.3 million, and a beneficial conversion feature of approximately $7.2 million, before issuance costs, based on the difference between the fair value of the underlying common stock at the commitment date of each Note transaction and the effective conversion price of the Notes, as limited by the proceeds allocated to the Notes.

Convertible promissory notes outstanding were as follows:



($ in thousands)	December 31,
($ in thousands)	2018			2017
Convertible promissory notes	$	18,003		$	18,003
Debt discount - warrants	(9,598		)	(9,598		)
Debt discount - compound bifurcated derivatives	(1,267		)	(1,267		)
Debt discount - beneficial conversion feature	(7,138		)	(7,138		)
Convertible promissory notes, net	$	—		$	—

The debt discount and issuance costs are amortized using the effective interest method over five years, the expected term of the Notes. Amortization of the debt discounts included in interest expense in the Consolidated Statement of Operations for the year ended December 31, 2018 and December 31, 2017 was approximately $0 and $0.1 million. Based on an effective yield of approximately 1157% resulting from the Notes being initially recorded at a full discount, the Company will not recognize any material amounts of amortization until years 2020 and 2021. The amortization of debt discount recorded in the year ended December 31, 2017 was related to the conversion of notes into shares.

Assumptions Used in Determining Fair Value of Compound Bifurcated Derivative

The Company utilizes a binomial lattice model to value its bifurcated derivatives included in the Notes. ASC 815 does not permit an issuer to account separately for individual derivative terms and features embedded in hybrid financial instruments that require bifurcation and liability classification as derivative financial instruments. Rather, such terms and features must be combined together and fair valued as a single, compound embedded derivative. The Company selected a binomial lattice model to value the compound embedded derivative because it believes this technique is reflective of all significant assumptions that market participants would likely consider in negotiating the transfer of the Notes. Such assumptions include, among other inputs:

Volatility. The Company estimates stock price volatility based on the Company’s historical stock price performance over a period of time that matches the volume-weighted average expected remaining life of the Notes.

Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury zero-coupon yield curve in effect at the valuation date commensurate with the expected remaining life assumption.

Expected remaining life. The expected life of the Notes is assumed to be equivalent to their remaining contractual term.

Dividend rate. The dividend rate is based on the historical rate, which the Company anticipates will remain at zero.

Scenarios. The probability of complex features of the compound bifurcated derivative being triggered is subjective (no observable inputs or available market data) and based on internal and external information known to management at the valuation date. Such assumptions include, among other inputs, probabilities related to a change of control and when it might occur as well as probabilities related to a default under the provisions of the Notes and when it might occur.

Changes to the key assumptions or to the scenarios used in the valuation model, including the probability of key events, such as a change of control transaction, and the credit spread could have a material impact to the overall valuation of the compound bifurcated derivative liability. A 5% change to the probability of a change of control event occurring in 2019 and 2020 would impact the derivative fair value by approximately $0.3 million and $0.1 million, respectively. A 5% change in the estimated credit spread would impact the derivative fair value by approximately $0.1 million. The sensitivity examples provided are included for illustrative purposes only and do not reflect the changes in these assumptions used by the Company. Changes in excess of those illustrated may occur in any period.

The estimated fair value of the compound bifurcated derivative is determined using Level 2 and Level 3 inputs. Significant inputs and assumptions used in the binomial lattice model for the derivative liability are as follows:



($ in thousands except per share data)	December 31, 2018			December 31, 2017
Calculated aggregate value	$	1,474		$	3,136
Closing price per share of common stock	$	1.50		$	3.20
Contractual remaining term	7 years, 8 months			8 years, 8 months
Contractual interest rate	4.0		%	4.0		%
Volume-weighted average conversion rate	$	17.04667		$	17.04667
Risk-free interest rate (term structure)	2.44% - 2.69%			1.28% - 2.40%
Dividend yield	—			—
Credit Rating	CC			CC
Credit Spread	31.77		%	36.98		%
Volatility	87.5		%	99.0		%

The foregoing compound bifurcated derivative was recorded at its estimated fair value at the date of issuance, with subsequent changes in estimated fair value recorded in derivative revaluation expense in the Company’s Consolidated Statement of Operations. The change in estimated fair value of the Company’s derivative liability for the years ended December 31, 2018 and December 31, 2017, resulted in non-cash income (expense) of approximately $1.7 million and $(1.4) million respectively.