UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark one)

For the quarterly period ended September 30, 2017

March 31, 2020

For the transition period from ___________ to ______________.

Commission file number: 000-24477

DIFFUSION PHARMACEUTICALS INC.

(Exact name of registrant as specified in its charter)

1317 Carlton Avenue, Suite 400200
Charlottesville, VA 22902
(Address of principal executive offices, including zip code)

(434) 220-0718

(Registrant’sRegistrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).Yes ☐   No ☒

The number of shares of common stock outstanding at November 10, 2017May 8, 2020 was 14,521,73045,989,932 shares.

DIFFUSION PHARMACEUTICALS INC.

FORM 10-Q

SEPTEMBER 30, 2017MARCH 31, 2020

INDEX

Unless the context otherwise requires, in this report, references to the “Company,” “we,” “our” or “us” refer to Diffusion Pharmaceuticals Inc. and its subsidiaries and references to “common stock” refer to the common stock, par value $0.001 per share, of the Company and references to "Series A convertible preferred stock" refer to the Series A convertible preferred stock, par value $0.001 per share, of the Company. On August 17, 2016, the Company effected a 1-for-10 reverse split of its common stock. Unless noted otherwise, any share or per share amounts in this report, the accompanying unaudited condensed consolidated financial statements and related notes give retroactive effect to this reverse stock split.

This report contains the following trademarks, trade names and service marks of ours: Diffusion. All other trade names, trademarks and service marks appearing in this quarterly report on Form 10-Q are the property of their respective owners. We have assumed that the reader understands that all such terms are source-indicating. Accordingly, such terms appear without the trade name, trademark or service mark notice for convenience only and should not be construed as being used in a descriptive or generic sense.

Diffusion Pharmaceuticals Inc. (“Diffusion” or the “Company”), a Delaware corporation, is a clinical stage biotechnology company focused on extending the life expectancy of cancer patientsdeveloping new treatments for life-threatening conditions by improving the effectiveness of current standard-of-care treatments, including radiation therapy and chemotherapy.body’s ability to bring oxygen to the areas where it is needed most. The Company is developing its lead product candidate, transcrocetinate sodium, also known as trans sodium crocetinate (“TSC”), for use in many cancer typesthose life-threatening conditions in which tumorcellular oxygen deprivation ("hypoxia"(“hypoxia”) is known to diminish the effectiveness of current treatments.basis for significant unmet medical needs. TSC is designed to safely and selectively target and re-oxygenate the cancer’smicro-environment of hypoxic micro-environment, re-oxygenatingcells, and can potentially be used in many indications, including stroke, oncology and cardiovascular disease. In stroke, TSC helps promote the diffusion of oxygen into those brain cells in which oxygen-deprivation causes neuronal death resulting in patient mortality or morbidity. In cancer, TSC re-oxygenates treatment-resistant cancerous tissue, and making the cancer cells up to three times more susceptible to the therapeutic effects of standard-of-care radiation therapy and chemotherapy. The U.S. Food and Drug Administration (“FDA”) provided Diffusion with final protocol guidance for a Phase 3 trial ofIn addition to the TSC in newly diagnosed inoperable GBM patients andprograms, the Company plansis exploring alternatives regarding how best to begincapitalize upon our product candidate RES-529, which may include possible out-licensing and other options. RES-529 is a novel PI3K/Akt/mTOR pathway inhibitor which has completed two Phase 1 clinical trials for age-related macular degeneration and is in preclinical development in oncology, specifically GBM. RES-529 has shown activity in both in vitro and in vivo glioblastoma animal models and has been demonstrated to be orally bioavailable and capable of crossing the trial by the end of 2017.blood brain barrier.

The Company has not generated any revenues from product sales and has funded operations primarily from the proceeds of public and private placementsofferings of its membership units (prior to the Merger),equity, convertible notesdebt and convertible preferred stock. Substantial additional financing will be required by the Company to continue to fund its research and development activities. No assurance can be given that any such financing will be available when needed or that the Company’sCompany’s research and development efforts will be successful.

The Company regularly explores alternative means of financing its operations and seeks funding through various sources, including public and private securities offerings, collaborative arrangements with third parties and other strategic alliances and business transactions. In March 2017, the Company completed a $25.0 million private placement of its securities by offering units consisting of one share of the Company's Series A convertible preferred stock and a warrant to purchase one share of common stock for each share of Series A convertible preferred stock purchased in the offering. The Company sold 12,376,329 units and received approximately $22.1 million in aggregate net cash proceeds from the private placement, after deducting commissions and other expenses of approximately $2.9 million. In addition, the Company granted to its placement agent in the offering warrants to purchase an aggregate 1,179,558 shares of common stock as compensation for its services.

The Company currently does not have any commitments to obtain additional funds and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If the Company cannot obtain the necessary funding, it will need to delay, scale back or eliminate some or all of its research and development programs or enter into collaborations with third parties to commercialize potential products or technologies that it might otherwise seek to develop or commercialize independently,independently; consider other various strategic alternatives, including a merger or sale of the Company,Company; or cease operations. If the Company engages in collaborations, it may receive lower consideration upon commercialization of such products than if it had not entered into such arrangements or if it entered into such arrangements at later stages in the product development process.

On May 26, 2017,Operations of the Company received a written notice from NASDAQ indicating the Company was not in compliance with Nasdaq Listing Rule 5550(b)(2) because the market value of the Company’s listed securities had been below $35.0 million for the previous 30 consecutive business days. NASDAQ also noted that as of such date the Company also did not meet the alternative requirements under Nasdaq Listing Rule 5550(b)(1), dueare subject to the Company's failure to maintain stockholders' equity of at least $2.5 million, or Nasdaq Listing Rule 5550(b)(3), due to the Company's failure to generate net income from continuing operations during its last fiscal year or during two of its last three fiscal years. See Note 12 for further details.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company has prepared its financial statements assuming that it will continue as a going concern, which contemplates realization of assetscertain risks and the satisfaction of liabilities in the normal course of business. The Company has incurred net losses since inception and it expects to generate losses from operations for the foreseeable future primarily due to research and development costs for its potential product candidates, which raises substantial doubt about the Company’s ability to continue as a going concern. Variousuncertainties including various internal and external factors that will affect whether and when the Company’s product candidates become approved drugs and the extent ofhow significant their market share. The regulatory approval and market acceptanceshare will be, some of which are outside of the Company’s proposed future products (if any),control. The length of time and cost of developing and commercializing these product candidates and/or failure of them at any stage of the drug approval process will materially affect the Company’s financial condition and future operations. The Company believes its cash and cash equivalents and certificateas of deposit at September 30, 2017March 31, 2020, along with the $4.8 million in proceeds received during the second quarter of 2020 related to warrant exercises, are sufficient to fund operations through June 2018. into the third quarter of 2021.

The Summary of Significant Accounting Policies included in the Company's Form 10-K for the year ended December 31, 2016,2019, filed with the Securities and Exchange Commission on March 31, 201717, 2020, have not materially changed, except as set forth below.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information as found in the Accounting Standard Codification (“ASC”) and Accounting Standards Updates (“ASUs”) of the Financial Accounting Standards Board (“FASB”), and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements of the Company include all normal and recurring adjustments (which consist primarily of accruals, estimates and assumptions that impact the unaudited interim consolidated financial statements) considered necessary to present fairly the Company’s financial position as of September 30, 2017,March 31, 2020, and its results of operations for the three and nine months ended September 30, 2017 and 2016 and cash flows for the ninethree months ended September 30, 2017March 31, 2020 and 2016.2019. Operating results for the ninethree months ended September 30, 2017March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2020. The unaudited interim condensed consolidated financial statements presented herein do not contain the required disclosures under GAAP for annual financial statements. The accompanying unaudited interim condensed consolidated financial statements should be read in conjunction with the annual audited financial statements and related notes as of and for the year ended December 31, 20162019 filed with the SEC on Form 10-K on March 31, 2017.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS17, 2020.

Use of Estimates

The preparation of the unaudited interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date the financial statements and reported amounts of expense during the reporting period. ActualThe full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results could differ fromof operations and financial condition, including sales, expenses, reserves and allowances, clinical trials, research and development costs and employee-related amounts, will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain it or treat COVID-19, as well as the economic impact on local, regional, national and international markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates.estimates in future periods. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the unaudited condensedinterim consolidated financial statements, actual results may materially vary from these estimates. Estimates and assumptions are periodically reviewed, and the effects of revisions are reflected in the unaudited interim condensed consolidated financial statements in the period they are deemeddetermined necessary.

Cash and Cash Equivalents and Certificate of Deposit

The Company considers any highly liquid investments, such as money market funds, with an original maturity of three months or less to be cash and cash equivalents. The Company's certificate of deposit has a maturity greater than three months but within one year of the date of purchase. This certificate of deposit is classified as held-to-maturity, and the estimated fair value of the investment approximates its amortized cost.

Fair Value of Financial Instruments

Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value determination in accordance with applicable accounting guidance requires that a number of significant judgments be made. Additionally, fair value is used on a nonrecurring basis to evaluate assets for impairment or as required for disclosure purposes by applicable accounting guidance on disclosures about fair value of financial instruments. Depending on the nature of the assets and liabilities, various valuation techniques and assumptions are used when estimating fair value. The carrying amounts of certain of the Company’sCompany’s financial instruments, including cash equivalents certificate of deposit,and accounts payable and accrued expenses approximateare shown at cost, which approximates fair value due to the short-term nature of thosethese instruments. AsThe Company follows the provisions of September 30, 2017, theFASB ASC Topic 820, Fair Value Measurement, for financial assets and liabilities measured on a recurring basis. The guidance requires fair value measurements be classified and disclosed in one of the Company's outstanding Series B convertible note was approximately $0.5 million. As of December 31, 2016,following three categories:

The following fair value ofhierarchy table presents information about the Company’s outstanding 2016 convertible note and Series B convertible note was approximately $2.0 million and $0.6 million, respectively. The 2016 convertible note was paid in full during the three month period ended September 30, 2017. Thecash equivalents measured at fair value of the convertible notes is determined usingon a binomial lattice model that utilizes certain unobservable inputs that fall within Level 3 of the fair value hierarchy.recurring basis:

Offering CostsIntangible Asset

Offering costs are either expensed upon completion or abandonment of the related financing or offset against the proceeds of the offering, depending upon the accounting treatment of the offering. Offering costs consist principally of legal costs incurred through the balance sheet date related to the Company’s private placement financings and are recognized in other assets on the consolidated balance sheet. During the three months ended September 30, 2017, management decided to not move forward with the Series B financing, which was originally contemplated and disclosed in theThe Company's definitive proxy statement filed with the Securities and Exchange Commission on May 1, 2017, and expensed $98,000 of previously capitalized offering costs related to the financing.

Intangible Assets and Goodwill

In connection with the Merger, the Company acquired indefinite-lived In-Process Research and Development Assets (“IPR&D”) RES-529 and RES-440, with estimated fair values of $8.6 million and $1.0 million, respectively, and recognized $6.9 million in goodwill. In the third quarter of 2016, the IPR&Dintangible asset associated with RES-440 was abandoned and written down to $0. RES-529 and goodwill areis assessed for impairment annually on each of October 1 of the Company’sCompany’s fiscal year or more frequently if impairment indicators exist. The Company has a single reporting unit and all goodwill relates to that reporting unit. There werewas no impairment indicators or impairments to the Company’s RES-529 or goodwillintangible asset recognized during both the three and nine months ended September 30, 2017.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTSMarch 31, 2020 and 2019.

Net Income (Loss)Loss Per Common Share

For the three and nine months ended September 30, 2017, the Company used the two-class method to compute basicBasic net incomeloss per common share because the Company has issued securities ("Series A convertible preferred stock") that entitle the holder to participate in dividends and earnings of the Company. Under this method,is computed by dividing net income is reduced by any dividends earned during the period. The remaining earnings ("undistributed earnings") are allocatedloss attributable to common stock and the Series A convertible preferred stock to the extent that the Series A convertible preferred stock may share in earnings. In periods of net loss, losses are not allocated to participating securities as the holders of such securities have no obligation to fund losses. The total earnings allocated to common stock is then dividedstockholders by the weighted average number of shares of common stock outstanding during each period. Diluted net loss per share includes the effect, if any, from the potential exercise or conversion of securities, such as convertible debt, convertible preferred stock, common stock warrants, stock options and unvested restricted stock that would result in the issuance of incremental shares outstanding to determineof common stock. In computing the basic earnings per share. 

For purposes of calculatingand diluted net loss per share applicable to common share, the denominator includes bothstockholders, the weighted average common shares outstanding and the number of common stock equivalents ifshares remains the inclusion of such common stock equivalents would be dilutive. Dilutive common stock equivalents potentially include stock options, unvested restricted stock awards and warrants usingsame for both calculations due to the treasury stock method. The Company considersfact that when a net loss exists, dilutive shares are not included in the potential dilutivecalculation as the impact of its convertible debt instruments using the "if-converted" method. In addition, the Company considers the potential dilutive impact of its convertible preferred shares using the “if-converted” method if more dilutive than the two-class method. For convertible preferred shares, the two-class method was more dilutive than the “if-converted” method for the three months ended September 30, 2017.is anti-dilutive.

The following potentially dilutive securities outstanding as of September 30, 2017March 31, 2020 and 20162019 have been excluded from the computation of diluted weighted average shares outstanding, as they would be anti-dilutive:

Amounts in the table reflect the common stock equivalents of the noted instruments.Recently Adopted Accounting Pronouncements

      Recent Accounting Pronouncements

In July 2017,August 2018, the FASB issued ASU 2017-11,2018-13, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. The first part of this update addresses the complexity of accounting for certain financial instruments with down round features and the second part addresses the complexity of distinguishing liabilities from equity. The guidance is applicable to public business entities for fiscal years beginning after December 15, 2018 and interim periods within those years. The Company is currently evaluating the potential impact of the adoption of this standard on its consolidated results of operations, financial position and cash flows and related disclosures.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In May 2017, the FASB issued ASU No. 2017-09, Modification Accounting for Share-Based Payment Arrangements, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changesDisclosure Framework-Changes to the terms or conditions of share-based payment awards to Disclosure Requirements for Fair Value Measurements, which an entity would be required to apply modification accounting under ASC 718. Specifically, an entity would not apply modification accounting ifchanges the fair value vesting conditions, and classificationmeasurement disclosure requirements of ASC 820. The goal of the awards areASU is to improve the same immediately beforeeffectiveness of ASC 820's disclosure requirements by providing users of the financial statements with better information about assets and afterliabilities measured at fair value in the modification. The guidance is applicable to public business entities for fiscal years beginning after December 15, 2017financial statements and interim periods within those years. Early adoption is permitted, including adoption in any interim period.notes thereto. The Company doesadopted ASU No. 2018-13 in the first quarter of 2020 and the adoption did not expect this new guidance to have a material impact on its condensedthe Company's consolidated financial statements.

Reverse Merger with RestorGenex

On January 8, 2016, the Company completed a reverse merger transaction with RestorGenex. The Company entered into the Merger transaction in an effort to provide improved access to the capital markets in order to obtain the resources necessary to accelerate development of TSC in multiple clinical programs and continue to build an oncology-focused company.

The purchase price was calculated as follows:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Merger transaction has been accounted for using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The valuation technique utilized to value the IPR&D was the cost approach.

The following table summarizes the allocation of the purchase price to the assets acquired and liabilities assumed as of the acquisition date:

Qualitative factors supporting the recognition of goodwill due to the Merger transaction include the Company’s anticipated enhanced ability to secure additional capital and gain access to capital market opportunities as a public company and the potential value created by having a more well-rounded clinical development portfolio by adding the earlier stage products acquired in the reverse merger transaction to the Company’s later stage product portfolio. The goodwill is not deductible for income tax purposes.

Pro Forma Financial Information (Unaudited)

The following pro forma financial information reflects the condensed consolidated results of operations of the Company as if the acquisition of RestorGenex had taken place on January 1, 2016. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed date.

Non-recurring pro forma transaction costs directly attributable to the Merger were $1.6 million for the nine months ended September 30, 2016 and have been deducted from the net loss presented above. The costs deducted from the nine months ended September 30, 2016 period includes a success fee of $1.1 million and approximately 46,000 shares of common stock with a fair market value of $0.5 million paid to a financial adviser upon the closing of the Merger on January 8, 2016. Additionally, RestorGenex incurred approximately $3.0 million in severance costs as a result of resignations of executive officers immediately prior to the Merger and approximately $2.7 million in share based compensation expense as a result of the acceleration of vesting of stock options at the time of the Merger. These costs are excluded from the pro forma financial information for the nine months ended September 30, 2016. No such costs were recorded in the three and nine months ended September 30, 2017 or in the three months ended September 30, 2016.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Prepaid expenses, deposits and other current assets consisted of the following:

Other accrued expenses and liabilities consisted of the following:

The components of debt outstanding at September 30, 2017 and December 31, 2016 are as follows:

Upon maturity of the 2016 Convertible Notes during the third quarter of 2017, the Company repaid the outstanding principal and interest of $1.9 million and $0.1 million, respectively. The accrued interest related to the Company’s Series B Convertible Note is included within accrued expenses and other current liabilities within the unaudited condensed consolidated balance sheets. As of September 30, 2017, the Company had accrued interest of approximately $36,000.

In contemplation of completing the private placement described below, the Company amended and restated its articles of incorporation and authorized 13,750,000 shares of Series A convertible preferred stock. The Company has classified its Series A convertible preferred stock outside of stockholders’ equity because the shares contain deemed liquidation rights that are contingent redemption features not solely within the control of the Company.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Series A Convertible Preferred Stock TransactionOfferings

In March 2017,December 2019, the Company completed an offering (the “December 2019 Offering”) of 6,266,787 shares of its common stock and warrants to purchase 6,266,787 shares of common stock. The shares of common stock and warrants were sold for a combined purchase price of $0.5585 per share for net proceeds of $3.0 million. The December 2019 Offering warrants are exercisable beginning on the date of their issuance until June 13, 2025 at an initial exercise price equal to $0.4335 per share.

In addition, at the closing of the December 2019 Offering, the Company issued warrants to purchase up to 313,339 shares of common stock to designees of the placement agent. The placement agent's warrants have an exercise price of $0.6981 per share and a term of five years from the date of issuance.

In November 2019, the Company completed a $25.0 million private placementregistered direct public offering (the “November 2019 Offering”) of 5,104,429 shares of its securities in which the Company offered and sold units consisting of one share of the Company’s Series A convertible preferredcommon stock, and a warrant6,324,143 pre-funded warrants each to purchase one share of common stock, for each share of Series A convertible preferred stock purchased in the offering. Each share of Series A convertible preferred stock entitles the holdertogether with warrants to an 8.0% cumulative dividend payable inpurchase up to 22,857,144 shares of our common stock at a combined public offering price of $0.35 per share and associated warrants for total net proceeds of $3.3 million. The warrants were issued with an exercise price of $0.35 per warrant and are exercisable beginning on their date of issuance. Of the warrants issued, 11,428,572 have a semi-annual basis. The holders may,term of 18 months and 11,428,572 have a term of five years. During the year ended December 31, 2019, 11,091,716 of those warrants were exercised for proceeds of $3.9 million.

In addition, at their option, convert each share of Series A convertible preferred stock into one sharethe closing of the Company’s common stock based onNovember 2019 Offering, the initial conversion price of $2.02 per share, subject to adjustment. Each warrant entitles the holderCompany issued warrants to purchase one shareup to 571,429 shares of common stock to designees of the placement agent. The placement agent's warrants have an exercise price of $0.4375 per share and a term of five years from the date of issuance.

In May 2019, the Company completed a registered direct public offering (the “May 2019 Offering”) of 1,317,060 shares of common stock and a private placement of warrants to purchase 1,317,060 shares of common stock. The shares of common stock and warrants were sold for a combined purchase price of $4.895 for total net proceeds of $5.6 million. The warrants are exercisable beginning on the date of their issuance until November 29, 2024 at an initial exercise price of $2.22, subjectequal to adjustment and expires on the fifth anniversary of their original issuance date.$5.00.

The Company sold 12,376,329 units in the private placement and received approximately $22.1 million in aggregate net cash proceeds, after deducting commissions and other expenses of approximately $2.9 million. In addition, as compensation for its services,at the closing of the May 2019 Offering, the Company granted to its placement agent in the offeringissued warrants to purchase an aggregate of 1,179,558up to 65,853 shares of common stock atto designees of the placement agent. The placement agent's warrants have an initial exercise price of $2.22$6.11875 per share which expire on the fifth anniversaryand a term of their original issuance date.

During its evaluation of equity classification for the common stock warrants, the Company considered the conditions as prescribed within ASC 815-40, Derivatives and Hedging, Contracts in an Entity’s own Equity (“ASC 815-40”). The conditions within ASC 815-40 are not subject to a probability assessment. As the Company is obligated to issue a variable number of shares to settle the cumulative dividends on the Series A convertible preferred stock, the Company cannot assert there will be sufficient authorized shares available to settle the warrants issued in connection with the Series A offering. Accordingly, these warrants are classified as liabilities. The Company will continue to classify such warrants as liabilities until they are exercised, expire, or are no longer required to be classified as liabilities.

As the fair value of the warrants upon issuance was in excess of the proceeds of the Series A offering, there are no proceeds allocated to the Series A convertible preferred stock. The excess fair value of the warrants over the gross proceeds of the Series A offering and the fair value of the warrants granted to its placement agent was $10.2 million in the aggregate and was recorded as warrant related expenses in the statement of operations for the nine months ended September 30, 2017.

Dividends

The Company shall pay a cumulative preferential dividend on each share of the Series A convertible preferred stock outstanding at a rate of 8.0% per annum, payable only in shares of common stock, semi-annually in arrears on April 1 and October 1 of each year commencing on October 1, 2017. This cumulative preferential dividend is not subject to declaration. The Company recognized approximately $0.4 million and $0.9 million in dividends, respectively, for the three and nine months ended September 30, 2017. 

Voting

Subject to certain preferred stock class votes specified in the Certificate of Designation of Preferences, Rights and Limitations of the Series A Convertible Preferred Stock (the “Certificate of Designation”) or as required by law, the holders of the Series A convertible preferred stock votes together with the holders of common stock as a single class on an adjusted as-converted basis. In accordance with NASDAQ listing rules, in any matter voted on by the holders of our common stock, each share of Series A convertible preferred stock entitles the holder thereof to a number of votes based upon the closing price of our common stock on the NASDAQ Capital Market onfive years from the date of issuance of such shares of Series A convertible preferred stock. Accordingly, shares of Series A convertible preferred stock issued in the initial closing of the private placement on March 14, 2017 are entitled to 0.84874 votes per share and shares of Series A Preferred Stock issued in the final closing of the private placement on March 31, 2017 are entitled to 0.50627 votes per share, in each case, subject to adjustment as described in the Certificate of Designation.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Liquidation Preference

The Series A convertible preferred stock is senior to the common stock. In the event of a liquidation, dissolution or winding up of the Company, either voluntary or involuntary, or in the event of a deemed liquidation event, which includes a sale of the Company as defined in the Certificate of Designation, the holders of the Series A convertible preferred stock shall be entitled to receive their original investment amount. If upon the occurrence of such event, the assets and funds available for distribution are insufficient to pay such holders the full amount to which they are entitled, then the entire remaining assets and funds legally available for distribution shall be distributed ratably among the holders of the Series A convertible preferred stock in proportion to the full amounts to which they would otherwise be entitled.issuance.

Conversion

The Series A convertible preferred stock is convertible, at the holder’s option, into common stock. At the Company’s option, the Series A convertible preferred stock can be converted into common stock upon (a) the thirty-day moving average of the closing price of the Company’s common stock exceeding $8.00 per share, (b) a financing of at least $10.0 million or (c) upon the majority vote of the voting power of the then outstanding shares of Series A convertible preferred stock. The conversion price of the Series A convertible preferred stock is subject to adjustment as described in the Certificate of Designation.

Upon any conversion, any unpaid dividends shall be payable to the holders of Series A convertible preferred stock. During the three and nine months ended September 30, 2017, 2,125,306 and 4,052,297 shares of Series A convertible preferred stock, respectively, were converted into common stock. During the three and nine months ended September 30, 2017, approximately $0.1 million and $0.2 million in accrued dividends, respectively, were converted into 62,701 and 88,436 shares of common stock, respectively.

Make-Whole Provision

Until March 2020 and subject to certain exceptions, if the Company issues at least $10.0 million of its common stock or securities convertible into or exercisable for common stock at a per share price less than $2.02 (such lower price, the “Make-Whole Price”) while any shares of Series A convertible preferred stock remain outstanding, the Company will be required to issue to these holders of Series A convertible preferred stock a number of shares of common stock equal to the additional number of shares of common stock that such shares of Series A convertible preferred stock would be convertible into if the conversion price of such shares was equal to 105% of the Make-Whole Price (the “Make-Whole Adjustment”). The Make-Whole Adjustment was evaluated and was not required to be bifurcated from the Series A convertible preferred stock.

Common Stock Warrants

As of September 30, 2017,March 31, 2020, the Company had the following warrants outstanding to acquire shares of its common stock:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

During the ninethree months ended September 30, 2017, 13,000March 31, 2020, no warrants issued prior to the Merger, expired. These common stockexpired, and 1,124,071 warrants will expire periodically through 2019. The common stock warrants issued in connection with the March 2017 Series A private placement expire in March 2022. During the three and nine months ended September 30, 2017, the Company recognized a net gainwere exercised at an exercise price of $8.4 million and $5.8 million in warrant related charges associated with the Series A private placement, which consisted primarily of the change in fair value of the common stock warrants from issuance and the excess fair value of the common stock warrants over the gross cash proceeds of the Series A offering. $0.35 per warrant.

2015 Equity Plan

The Diffusion Pharmaceuticals Inc. 2015 Equity Incentive Plan, as amended (the "2015 Equity Plan"), provides for increases to the number of shares reserved for issuance thereunder each January 1 equal to 4.0% of the total shares of the Company’sCompany’s common stock outstanding as of the immediately preceding December 31, unless a lesser amount is stipulated by the Compensation Committee of the Company's Boardboard of Directors.directors. Accordingly, 413,8251,339,215 shares were added to the reserve as of January 1, 2017,2020, which shares may be issued in connection with the grant of stock-based awards, including stock options, restricted stock, restricted stock units, stock appreciation rights and other types of awards as deemed appropriate, in each case, in accordance with the terms of the 2015 Equity Plan. As of September 30, 2017,March 31, 2020, there were 114,291485,602 shares of common stock available for future issuance under the 2015 Equity Plan.

The Company recorded stock-based compensation expense in the following expense categories of its unaudited interim condensed consolidated statements of operations for the periods indicated:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the activity related to all stock option grants to employees and non-employees for the nine months ended September 30, 2017:

Non-employee Stock Options

Non-employee options are remeasured to fair value each period using a Black-Scholes option-pricing model until the options vest. During the nine months ended September 30, 2017, the Company granted 9,394 stock options to non-employees. The total fair value of non-employee stock options vested during the three months ended September 30, 2017 and 2016 was approximately $7,000 and $0.2 million, respectively. The total fair value of non-employee stock options vested during the nine months ended September 30, 2017 and 2016 was approximately $83,000 and $0.7 million, respectively. At September 30, 2017, there were 18,572 unvested options subject to remeasurement and approximately $26,000 of unrecognized compensation expense that will be recognized over a weighted-average period of 1.64 years.March 31, 2020:

Employee Stock Options

During the nine months ended September 30, 2017, the Company granted 330,647 stock options to employees. The weighted average grant date fair value of stock option awards granted to employees was $2.12$0.36 during the nine months ended September 30, 2017. During the three months ended September 30, 2017March 31, 2020. The total fair value of options vested during the three months ended March 31, 2020 and 2016 the Company recognized stock-based compensation expense of $0.32019 was $0.2 million and $0.1 million, respectively. During the nine months ended September 30, 2017 and 2016, the Company recognized stock-based compensation expense $0.9 million and $0.4$0.2 million, respectively. No options were exercised during any of the periods presented. At September 30, 2017,March 31, 2020, there was $2.8$0.4 million of unrecognized compensation expense that will be recognized over a weighted-average period of 5.331.81 years.

Options granted were valued using the Black-Scholes model and the weighted average assumptions used to value the options granted during the first ninethree months of 2017ended March 31, 2020 were as follows:

Restricted Stock Awards

As of September 30, 2017, there were 4,599 unvested shares of restricted stock. During the three months ended September 30, 2017 and 2016, there were 1,533 and 1,534 shares that vested, respectively andMarch 31, 2020, the Company recognized stock-based compensation expensegranted 98,100 restricted stock awards to a member of approximately $3,000 and $3,000, respectively. During the nineboard of directors of the Company. The grant date fair value of each restricted stock award granted during the three months ended September 30, 2017 and 2016, there were 4,599 and 4,603March 31, 2020 was $0.51. The shares that vested, respectively andbegin to vest 18 months after the grant date. The Company recognized stock-based compensationapproximately $4,000 in expense of approximately $9,000related to this award during the three months ended March 31, 2020 and, $9,000, respectively. At September 30, 2017,at March 31, 2020, there was approximately $9,000$46,000 of unrecognized compensation expensecost that will be recognized over a weighted-averageweighted average period of less than 1.0 year.2.83 years.

Office Space Lease CommitmentRental

The Company leaseshas a non-cancelable operating lease for office and laboratory facilitiesspace in Charlottesville, Virginia. On MarchVirginia, which began in April 2017 and, as of December 31, 2017,2019, has a remaining lease term of approximately 2.3 years. The Company adopted ASC 842 in the first quarter of 2019 and as a result of the adoption, the Company entered intorecognized a current operating lease liability of $0.1 million and a noncurrent operating lease liability of $0.2 million with a corresponding ROU asset of the combined amounts, which is based on the present value of the minimum rental payments of the lease. The discount rate used to account for its officethe Company's operating lease under ASC 842 is the Company’s estimated incremental borrowing rate of 10%. The original term of the lease ends in the second quarter of 2022 and laboratory facilities at a new location in Charlottesville, Virginia. During the nine months ended September 30, 2017, the Company capitalized approximately $0.4 million in leasehold improvementshas an option to extend for another five years. This option to extend was not recognized as part of the build outCompany's measurement of the new officeROU asset and laboratory location. operating lease liability as of March 31, 2020.

Rent expense related to the Company's operating leaseslease was approximately $30,000 and $20,000 for the three months ended September 30, 2017March 31, 2020 and 2016 was $28,000 and $34,000,2019, respectively. Rent expense for the nine months ended September 30, 2017 and 2016 was $80,000 and $115,000, respectively. For the new operating lease, lease payments commenced on May 1, 2017 and expire on April 30, 2022. The Company will continue to recognize rent expense on a straight-line basis over the lease period and will accrue for rent expense incurred but not yet paid. Future minimum rental payments under the Company's new non-cancelable operating lease at September 30, 2017 was as follows:follows as of March 31, 2020:

Arrangement with Clinical Research Organizationand Development Arrangements

On July 5, 2017,In the course of normal business operations, the Company enteredenters into a Master Services Agreement ("MSA")agreements with auniversities and contract research organization ("CRO")organizations, or CROs, to provide clinical trial services for individual studies and projects by executing individual work orders. The MSA and associated work orders are designed such that quarterly payments are to be madeassist in advancethe performance of the work to be performed.  The Company recognized research and development expensesactivities and contract manufacturers to assist with chemistry, manufacturing, and controls related expenses. Expenditures to this MSACROs represent a significant cost in clinical development for the Company. The Company could also enter into additional collaborative research, contract research, manufacturing, and supplier agreements in the future, which may require upfront payments and long-term commitments of $0.6 millioncash.

Defined Contribution Retirement Plan

The Company has established a 401(k) defined contribution plan (the “401(k) Plan”) that covers all employees who qualify under the terms of the plan. Eligible employees may elect to contribute to the 401(k) Plan up to 90% of their compensation, limited by the IRS-imposed maximum. The Company provides a safe harbor match with a maximum amount of 4% of the participant’s compensation. The Company made matching contributions under the 401(k) Plan of approximately $17,000 and $18,000 for the three months ended September 30, 2017.  As of September 30, 2017, there was $1.0 million of prepaid researchMarch 31, 2020 and development costs that are estimated to be recognized during the fourth quarter of fiscal 2017.2019, respectively.

Legal Proceedings

On August 7, 2014, a complaint was filed in the Superior Court of Los Angeles County, California by Paul Feller, the Company’sCompany’s former Chief Executive Officer under the caption Paul Feller v. RestorGenex Corporation, Pro Sports & Entertainment, Inc., ProElite, Inc. and Stratus Media Group, GmbH (Case No. BC553996). The complaint asserts various causes of action, including, among other things, promissory fraud, negligent misrepresentation, breach of contract, breach of employment agreement, breach of the covenant of good faith and fair dealing, violations of the California Labor Code and common counts. The plaintiff is seeking, among other things, compensatory damages in an undetermined amount, punitive damages, accrued interest and an award of attorneys’ fees and costs. On December 30, 2014, the Company filed a petition to compel arbitration and a motion to stay the action. On April 1, 2015, the plaintiff filed a petition in opposition to the Company’s petition to compel arbitration and a motion to stay the action. After a hearing for the petition and motion on April 14, 2015, the Court granted the Company’s petition to compel arbitration and a motion to stay the action. On January 8, 2016, the plaintiff filed an arbitration demand with the American Arbitration Association. NoOn November 19, 2018 at an Order to Show Cause Re Dismissal Hearing, the Court found sufficient grounds not to dismiss the case, and an arbitration hearing has yet been scheduled.scheduled for November 2020. The Company believes this matter is without merit and intends to defend the arbitration vigorously. Because this matter is in an early stage, the Company is unable to predict its outcome and the possible loss or range of loss, if any, associated with its resolution or any potential effect the matter may have on the Company’s financial position. Depending on the outcome or resolution of this matter, it could have a material effect on the Company’s financial position.

Certain assetsIn April 2020, the Company announced the pre-IND submission to the U.S. Food and liabilitiesDrug Administration (“FDA”) of a planned clinical program using TSC in COVID-19 patients displaying severe respiratory symptoms and low oxygen levels. Under federal regulations, the FDA has up to 60 days to hold an advisory meeting with the Company, but for COVID-19-related submissions, the FDA has announced its intention to significantly shorten this period under its Coronavirus Treatment Acceleration Program. Clinical trial start-up preparations are carried at fair value under GAAP. Fair value is definedcontinuing as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) inCompany awaits 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 must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:FDA’s response.

•       Level 1—Quoted prices in active markets for identical assets or liabilities.

•       Level 2—Observable inputs (other than LevelFrom April 1, quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.

•      Level 3—Unobservable inputs that are supported by little or no market activity and that are significant2020 through May 8, 2020, warrants were exercised to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The reconciliation of the common stock warrant liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is as follows:

The common stock warrants issued in connection with the Series A convertible preferred stock are classified as liabilities on the accompanying balance sheet at September 30, 2017. The liability is marked-to-market each reporting period with the change in fair value recorded as either income or expense in the accompanying statements of operations until the warrants are exercised, expire or other facts and circumstances lead the liability to be reclassified to stockholders’ equity. The fair value of the warrant liability is estimated using the Black-Scholes model and assumptions used to value the warrant liability as of September 30, 2017 were as follows:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On November 1, 2017 the Company held a Special Shareholders meeting, requesting shareholders, both common and Series A, to approve a proposed amendment to the Company’s Certificate of Incorporation to permit the Company to pay dividends on the Company’s Series A Convertible Preferred Stock in either cash orpurchase 6,385,496 shares of the Company’s Common Stock, which was approved by the shareholders. As a resultcommon stock for gross proceeds of this amendment,approximately $2.5 million.

On May 8, 2020, the Company is ablecompleted a warrant exchange and related private placement (the “Exchange”). In the Exchange, an existing holder of the Company’s warrants exercised warrants to assert there will be sufficient authorizedpurchase 5,000,000 shares availableof the Company’s common stock and also purchased new unregistered warrants to settlepurchase up to 5,000,000 shares of common stock (the “New Warrants”), for gross proceeds of approximately $2.4 million. The New Warrants have an exercise price of $0.5263 per share, are exercisable immediately upon issuance, and which have a term of exercise equal to five and one-half years. In connection with the Series A warrants. Upon this assertion,Exchange, the Series ACompany issued warrants were reclassified from liabilities to stockholders’ equity. Priorpurchase up to 250,000 shares of the Company’s common stock (the “May 2020 PA Warrants”) to the amendment,H.C. Wainwright & Co. LLC, as compensation for accounting purposes, the warrants were recordedits role as a liability under U.S. generally accepted accounting principles.placement agent in such Exchange. The warrant liability resulted in a reductionMay 2020 PA Warrants have an exercise price of our stockholders’ equity, as of March 31, 2017$0.5938 per share, are exercisable immediately upon issuance, and June 30, 2017, below the required level under the Nasdaq Capital Market’s continued listing standards. The Charter Amendment, by permitting the Companyhave an exercise term equal to assert share settlement of the warrants, resulted in a reclassification of the warrant liability to stockholders’ equity as of the date of the amendment.five and one-half years.

It is therefore the belief of the Company that this fundamental change will allow the Company to regain its NASDAQ compliant status. The following pro-forma information shows adjustments to the September 30, 2017 balances to (i) remove the Series A warrant liability of $16.3 million as of September 30, 2017 from total liabilities, (ii) show the reclassification of the fair value of the Series A warrants of $13.2 million as of November 1, 2017 to APIC, and (iii) to adjust the accumulated deficit balance for the change in fair value of the Series A warrants from September 30, 2017 to November 1, 2017 of $3.2 million.