Sun BioPharma, Inc. andtogether with its wholly-owned subsidiary Sun BioPharma Australia Pty Ltd. (collectively “we,” “us,” “our,” and the “Company”) exist, exists for the primary purpose of advancing the commercial development of a proprietary polyamine analogue (the “compound”) for the treatment of patients with pancreatic cancer and for a potential second indication infor the treatment of patients with chronic and recurrent acute pancreatitis. We have exclusively licensed the worldwide rights to this compound, which has been designated as SBP-101, from the University of Florida Research Foundation, Inc. (“UFRF”).

Effective November 7, 2017, we implemented a 1-for-10 reverse split of our common stock. All references to share and per share amounts included in these Condensed Consolidated Financial Statements have been retroactively restated to reflect the reverse split.

The Company operates in a highly regulated and competitive environment. The development, manufacturing and marketing of pharmaceutical products require approval from, and are subject to ongoing oversight by, the Food and Drug Administration (“FDA”) in the United States, the Therapeutic Goods Administration (“TGA”) in Australia, the European Medicines Agency (“EMA”) in the European Union, and comparable agencies in other countries. Obtaining approval for a new pharmaceutical product is never certain, may take many years, and is normally expected to involve substantial expenditures.

We have incurred losses of $33.4$38.9 million since our inception in 2011. For the six months ended June 30, 2018,2019, we incurred a net loss of $4.2$3.9 million, which includes the amortization of discount on debt of $1.7$2.1 million. We also incurred negative cash flows from operating activities of $1.6$1.4 million forduring this period. During this same period, we raised $2.3$0.8 million from the sale of equity securities,convertible promissory notes and had a non-cash conversion of promissorywarrants to purchase common stock, as discussed in Note 4 titled “Liquidity and Business Plan”. These notes, sold in January 2019, and notes sold in December 2018 converted into common stock totaling $3.3 million in principal and accrued interest. We expect to incur substantial losses for the foreseeable future, which will typically generate negative net cash flows from operating activities, ason June 30, 2019. As we continue to pursue development activities and seek to commercializecommercialization of our initial product candidate, SBP-101.SBP-101, we expect to incur substantial losses, which are likely to generate negative net cash flows from operating activities. As of June 30, 2018,2019, we had cash of $0.9$0.7 million, working capital (current assets less current liabilities) of $0.1$0.6 million and stockholders’ equitydeficit of $0.1 million. The Company’s principal sources of cash have historically included the issuance of convertible debt and equity securities.

The accompanying condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The condensed consolidated financial statements do not include any adjustments relating to the recoverability or classification of assets or the amounts of liabilities that might result from the outcome of these uncertainties. Our current independent registered public accounting firm included a paragraph emphasizing this going concern uncertainty in their audit report regarding our 20172018 financial statements dated March 21, 2018.22, 2019. Our ability to continue as a going concern, realize the carrying value of our assets and discharge our liabilities in the ordinary course of business is dependent upon a number of factors, including our ability to obtain additional financing, the success of our development efforts, our ability to obtain marketing approval for our SBP-101 product candidate in the United States, Australia, the European Union or other markets and ultimately our ability to market and sell our SBP-101 product candidate. These factors, among others, raise substantial doubt about our ability to continue operations as a going concern. See Note 4 titled “Liquidity and Management’s Plans.Business Plan.”

We have prepared the accompanying interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These interim condensed consolidated financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management, are necessary to present fairly our consolidated financial position, consolidated results of operations and consolidated cash flows for the periods and as of the dates presented. Our fiscal year ends on December 31. The condensed consolidated balance sheet as of December 31, 20172018 was derived from audited consolidated financial statements but does not include all disclosures required by U.S. GAAP. These interim condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements and the notes thereto included in our most recent filed Annual Report on Form 10-K and our othersubsequent filings with the SEC. The nature of our business is such that the results of any interim period may not be indicative of the results to be expected for the entire year.

Recently Adopted Accounting Pronouncements

In May 2014,June 2018, the Financial Accounting Standards Board (“FASB”(the “FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements of Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” and most industry-specific guidance on revenue recognition throughout the ASC. The new standard is principles-based and provides a five-step model to determine when and how revenue is recognized. The core principle of the new standard is that revenue should be recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also requires disclosure of qualitative and quantitative information surrounding the amount, nature, timing and uncertainty of revenues and cash flows arising from contracts with customers. The Company has evaluated the impact of this revised guidance on its financial statements and determined it had no material impact.

In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing.” ASU 2016-10 clarifies the implementation guidance on identifying performance obligations. These ASUs apply to all companies that enter into contracts with customers to transfer goods or services. This ASU is effective for public entities for interim and annual reporting periods beginning after December 15, 2017. The Company has evaluated the impact of this revised guidance on its financial statements and determined it had no material impact.

Recently Issued Accounting Pronouncements

In June 2018, the FASB issued (“ASU”) 2018-07, “Compensation – Stock Compensation (Topic 718).” ASU 2018-07 simplifies the accounting for nonemployee stock-based payment transactions. This ASU iswas adopted by the Company effective for public entities for interim and annual reporting periodsthe fiscal year beginning after December 15, 2018.January 1, 2019. Historically, the ultimate stock-based compensation related to non-employee common stock options would fluctuate based on changes in the underlying option pricing model as the awards vest. Under the new guidance, the total compensation cost of non-employee options is determined at grant date. The Company is currently evaluatinghas evaluated the potential impact of this new guidance on its financial statements and at this time does not believehas determined that it will havehas affected how the Company records stock-based compensation related to common stock options and other equity-based compensation, if any, granted to non-employees.

In February 2016, the FASB issued ASU 2016-02, “Leases,” which created a new Topic, Accounting Standards Codification (“ASC”) Topic 842 and established the core principle that a lessee should recognize the assets, representing rights-of-use, and liabilities to make lease payments, that arise from leases.  For leases with a term of 12 months or less, a lessee is permitted to make an election under which such assets and liabilities would not be recognized, and lease expense would be recognized generally on a straight-line basis over the lease term.  This standard was adopted by the Company for the year beginning January 1, 2019. The Company has evaluated the impact of this revised guidance on its financial statements and determined it had no material impact, onas the Company’s financial statementsCompany has no leasing arrangements with terms greater than one year.

We will need to obtain additional funds to continue our operations and execute our current business plans. We may seek to raise additional funds through various sources, such as equity and debt financings, or through strategic collaborations and license agreements. We can give no assurances that we will be able to secure additional sources of funds to support our operations, or if such funds are available to us, that such additional financing will be sufficient to meet our needs or on terms acceptable to us. This risk would increase if our clinical data is inconclusive or not positive or economic conditions worsen in the market as a whole or in the pharmaceutical or biotechnology markets individually.

Between March 1, 2016In closings occurring in December 2018 and SeptemberJanuary 2019 the Company sold $2.2 million principal amount of unsecured convertible promissory notes (the “Notes”) and warrants to purchase up to 1,243,498 shares of common stock (the “Warrants”) in a private placement to certain investors pursuant to a Securities Purchase Agreement. On June 30, 2017, we2019 the principal balance and accrued a portioninterest of cash base salaries for all senior employees in an effort to conserve cash. In lieu$105,000 converted into 651,758 shares of a portion of base salary,common stock per the affected employees were entitled to receive a cash payment in an amount equal to the foregone salary. The cash payment would have become due upon a change of control or the issuance of equity securities resulting in cash gross proceeds of $10 million or more. As of December 31, 2017, the contingent payments under these arrangements totaled $1.1 million. On February 27, 2018, eachterms of the affected employees agreed to waive their rights to receive the contingent payments in exchange for common stock options.Notes at a conversion rate of $3.50. See Note 6 titled “Employment agreement amendments and waiver“Indebtedness” for a detailed discussion of contingent payment rights.”

On February 20, 2018, we entered into a Securities Purchase Agreement (the “2018 Purchase Agreement”) with certain accredited investors and completed an initial closing on the same date. Pursuant tomaterial terms of the initial closing, we sold a total of 168,000 shares of common stock and warrants to purchase an aggregate of up to the same number of additional shares of common stock.Notes.  The warrants issued under the 2018 Purchase Agreement will beWarrants are exercisable for a period of threefive years from the date of issuance at an initial exercise price of $5.00 per share. On March 16, 2018 and May 16, 2018, we completed additional closings under the 2018 Purchase Agreement, resulting in the sale of an additional 84,200 and 216,000, respectively, shares of common stock and warrants to purchase up to the same number of additional shares of common stock. We have received aggregate gross proceeds totaling $2.3 million pursuant to private placements under the 2018 Purchase Agreement, of which $125,000 was received from directors and officers of the Company or its subsidiary. The 2018 Purchase Agreement contemplates subsequent closings that could result in up to an additional 885,521 units (each consisting of one share of common stock and a warrant to purchase one additional share of common stock).

On May 16, 2018, as the result of receiving aggregate gross proceeds exceeding $2.0 million for the sale equity securities, under terms of the convertible debt, the Company completed the conversion of previously outstanding debt. Debt totaling $330,500 and accrued interest totaling approximately $19,500 was converted into 104,463 shares of common stock. Debt totaling approximately $2.7 million and accrued interest totaling approximately $163,500 was converted into 646,279 units (each consisting of a share of common stock and a warrant to purchase one additional share of common stock). The units were available through the 2018 Purchase Agreement.$4.50.

If we are unable to obtain additional financing when needed, we believe that will need to reduce our operations by taking actions that may include, among other things, reducing use of outside professional service providers, reducing staff or further reducing staff compensation, significantly modifying or delaying the development of our SBP-101 product candidate, licensing rights to third parties, including the right to commercialize our SBP-101 product candidate for pancreatic cancer, recurrent acute and/or chronic pancreatitis or other applications that we would otherwise seek to pursue, or discontinuing operations entirely.

Our future success is dependent upon our ability to obtain additional financing, the success of our development efforts, our ability to obtain marketing approval for our SBP-101 product candidate in the United States or other markets and ultimately our ability to market and sell our SBP-101 product candidate. If we are unable to obtain additional financing when needed, if our clinical trials are not successful or if we are unable to obtain marketing approval, we would not be able to continue as a going concern and would be forced to cease operations and liquidate our company.

There can be no assurances that we will be able to obtain additional financing on commercially reasonable terms, or at all. The sale of additional convertible debt or equity securities would likely result in dilution to our current stockholders.

Principles of consolidation

The accompanying condensed consolidated financial statements include the assets, liabilities and expenses of Sun BioPharma, Inc. and our wholly-owned subsidiary, Sun BioPharma Australia Pty Ltd.the Company. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of estimates

The preparation of condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of expenses during the reporting period. Actual results could differ from those estimates.

Beneficial conversion featureconversion features

For convertible debt where the rate of conversion is below fair market value for our common stock, the Company records a "beneficialbeneficial conversion feature" ("BCF")feature and related debt discount that is presented as a direct deduction from the carrying amount of the related debt and as an increase to additional paid-in capital. The debt discount is amortized through interest expense over the life of the related debt.

Debt issuance costs

Costs associated with the issuance of debt instruments are capitalized and presented as a direct deduction from the carrying amount of the related debt liability. These costs are amortized through interest expense over the life of the related debt.

Research and development costs

Research and development costs include expenses incurred in the conduct of our second Phase 1 human clinical trial, for third-party service providers performing various testing and accumulating data related to our preclinical studies; sponsored research agreements; developing and scaling the manufacturing process necessary to produce sufficient amounts of the SBP-101 compound for use in our pre-clinical studies and human clinical trials; consulting resources with specialized expertise related to execution of our development plan for our SBP-101 product candidate; personnel costs, including salaries, benefits and share-based compensation; and costs to license and maintain our licensed intellectual property.

We charge research and development costs, including clinical trial costs, to expense when incurred. Our human clinical trials are, and will be, performed at clinical trial sites and are administered jointly by us with assistance from contract research organizations (“CROs”). Costs of setting up clinical trial sites are accrued upon execution of the study agreement. Expenses related to the performance of clinical trials generally are accrued based on contracted amounts and the achievement of agreed upon milestones, such as patient enrollment, patient follow-up, etc. We monitor levels of performance under each significant contract, including the extent of patient enrollment and other activities through communications with the clinical trial sites and CROs, and adjust the estimates, if required, on a quarterly basis so that clinical expenses reflect the actual effort expended at each clinical trial site and by each CRO.

All material CRO contracts are terminable by us upon written notice and we are generally only liable for actual effort expended by the CROs and certain non-cancelable expenses incurred at any point of termination.

We expense costs associated with obtaining licenses for patented technologies when it is determined there is no alternative future use of the intellectual property subject to the license.

Stock-basedStock-based compensation

In accounting for stock-based incentive awards, we measure and recognize the cost of employee and non-employee services received in exchange for awards of equity instruments based on the grant date fair value of those awards.awards on the grant date. Calculating stock-based compensation expense requires the input of highly subjective assumptions, which represent our best estimates and involve inherent uncertainties and the application of management’s judgment. Compensation cost is recognized ratably using the straight-line attribution method over the vesting period, which is considered to be the requisite service period. The performance date for non-employee awards is generally not met until the individual award vests. Accordingly, we re-measure the current fair value each quarter until the award vests. Compensation expense for performance-based stock option awards is recognized when “performance” has occurred or is probable of occurring.

The fair value of stock-based awards is estimated at the date of grant using the Black-Scholes option pricing model. The determination of the fair value of stock-based awards is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. Risk free interest rates are based upon U.S. Treasury rates appropriate for the expected term of each award. Expected volatility rates are based primarily on the volatility rates of a set of guideline companies, which consist of public and recently public biotechnology companies. The assumed dividend yield is zero, as we do not expect to declare any dividends in the foreseeable future. The expected term of options granted is determined using the “simplified” method. Under this approach, the expected term is presumed to be the mid-point between the average vesting date and the end of the contractual term. Forfeitures of unvested stock options are recognized as they occur.

Foreign currency translation adjustments

The functional currency of Sun BioPharma Australia Pty Ltd is the Australian Dollar (“AUD”).Dollar. Accordingly, assets and liabilities, and equity transactions of Sun BioPharma Australia Pty Ltd are translated into U.S. dollars at period-end exchange rates. Revenues and expenses are translated at the average exchange rate in effect for the period. The resulting translation gains and losses are recorded as a component of accumulated comprehensive loss presented within the statements of stockholders’ equity (deficit). During the six-month periods ended June 30, 20182019 and 2017,2018, any reclassification adjustments from accumulated other comprehensive loss to operations were inconsequential.

Comprehensive loss

Comprehensive loss consists of our net loss and the effects of foreign currency translation.

Net loss per share

Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is based on the weighted-averageweighted average of common shares outstanding during the period plus dilutive potential common shares calculated using the treasury stock method. Such potentially dilutive shares are excluded when the effect would be anti-dilutive or reduce a net loss per share. The Company’s potential dilutive shares, which include convertible debt, outstanding common stock options, and warrants, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive.

The following table sets forth the potential shares of common stock that were not included in the calculation of diluted net loss per share as their effects would have been anti-dilutive:anti-dilutive as of:

Effective February 27, 2018, we enteredNotes

On June 30, 2019, all $2.2 million aggregate principal balance of Notes outstanding plus $105,000 of accrued interest was converted at a conversion rate of $3.50 per share of common stock into waivers and third amendments (collectively,651,758 shares of common stock per the “Amendments”) to the previously disclosed employment agreements, as amended (the “Agreements”), with our Executive Chairman, Michael T. Cullen, M.D., M.B.A., our President and Chief Executive Officer, David B. Kaysen, and our former Chief Financial Officer, Scott Kellen, each of whom was an executive officerterms of the Company (collectively,Notes. The Notes were issued in December 2018 and January 2019 and bore interest at a rate of 10.0% per year. Both the “Executives”), and our Chief Medical Officer, Suzanne Gagnon, M.D. (together with the Executives, the “Employees”). Dr. Cullen, Mr. Kaysen and Dr. Gagnon are also current membersrelative value of the Company’s Board of Directors.

For eachWarrants and the beneficial conversion feature of the Employees, the Amendments waived the contingent cash payment and/or equity payments that had been established by the amendments to the Agreements dated October 1, 2017, each of which could have become due upon a change of control or the Company’s completion of an underwritten public offering of its common stock before June 30, 2018. The potential payments waived by the Employees totaled $1.1 million at the time of the amendments and wasNotes were recorded as a reductiondebt discount at the times the Notes were sold which was presented as a direct deduction from the carrying value of the Notes. The discount was fully amortized through interest expense immediately prior to the conversion on June 30, 2019.

Term debt

Effective April 5, 2019 the terms of our unsecured loan (the “Term Debt”) payable to the Institute for Commercialization of Public Research, Inc. (the “Institute”) were amended to extend the maturity date from May 1, 2019 to December 31, 2019.  The Institute agreed to the amendment in salary expense. The Amendments also entitled Dr. Cullen, Mr. Kaysen, Mr. Kellen and Dr. Gagnon to grants of new non-qualified stock optionsexchange for a warrant to purchase up to 100,000 shares, 50,000 shares, 25,000 shares and 95,0005,555 shares of Company common stock respectively, at an exercise price equal toof $4.50. The warrant expires five years from issuance. The fair market value as of the datewarrant was nominal and as such has not been given any accounting treatment. The amendment requires the continuation of grant. These options vested upon grantmonthly payments of principal and have option terms of 10 years.interest totaling $10,000. The options were granted underunpaid principal balance at June 30, 2019 was $232,000.

Unsecured Promissory Notes

On May 17, 2019 the Company executed an unsecured promissory note with a vendor that relieved the Company’s 2016 Omnibus Incentive Plan effectiveimmediate obligation to pay the outstanding vendor invoices. The outstanding vendor invoices totaling approximately $742,000 were removed from the Company’s accounts payable as consideration for the promissory note.  The promissory note is unsecured, does not bear interest and the balance is payable in full on the earlier of February 27, 2018 and had(1) December 31, 2020 or (2) the date the Company’s stock is registered on a fair value of approximately $1.3 million which was recorded as stock-based compensation expense.national exchange.

Private PlacementShares

During the six months ended June 30, 2018, we issued an aggregate of 468,200 shares of our common stock and warrants to purchase an aggregate of up to the same number of additional shares of common stock pursuant to closings under the 2018 Purchase Agreement.  Total proceeds from the salereserved for future issuance were as follows as of common stock and warrants was $2.3 million. Pursuant to the 2018 Purchase Agreement, we may be required to file a registration statement with the SEC covering the resale of the shares issued and/or warrant shares issuable thereunder. See Note 4, titled “Liquidity and Management’s Plans.”

Debt ConversionJune

During the six months ended June 30, 2018, the Company issued 104,463 shares of common stock as the result of the conversion of previously outstanding debt totaling $330,500 and accrued interest totaling approximately $19,500. Also during the six months ended June 30, 2018, the Company issued 646,279 units (each consisting of a share of common stock and a warrant to purchase one additional share) as the result of the conversion of previously outstanding debt totaling approximately $2.7 million and accrued interest totaling approximately $163,500. The units were issued to note holders selecting an alternative conversion from units made available under the 2018 Purchase Agreement. The conversion occurred under the original terms of the convertible debt.

Shares reserved 30, 2019:

2016 Omnibus Incentive Plan

The Sun BioPharma, Inc. 2016 Omnibus Incentive Plan (the “2016 Plan”) was adopted by our Board of Directors in March 2016 and approved by our stockholders in May 2016. The 2016 Plan permits the granting of incentive and non-statutory stock options, restricted stock, stock appreciation rights, performance units, performance shares and other stock awards to eligible employees, directors and consultants. We grant options to purchase shares of common stock under the 2016 Plan at no less than the fair market value of the underlying common stock as of the date of grant. Options granted under the 2016 Plan have a maximum term of ten years. Under the 2016 Plan, a total of 1,500,000 shares of common stock were initially reserved for issuance. As of June 30, 2018,2019, options to purchase 843,6001,285,711 shares of common stock were outstanding under the 2016 Plan and 656,400212,149 shares remained available for future awards.

2011 Stock Option Plan

Our Board of Directors ceased making awards under the Sun BioPharma, Inc. 2011 Stock Option Plan (the “2011 Plan”) upon the receipt of stockholder approval for the 2016 Plan. Awards outstanding under the 2011 Plan remain outstanding in accordance with and pursuant to the terms thereof. Options granted under the 2011 Plan have a maximum term of ten years and generally vest over zero to two years for employees. As of June 30, 2018,2019, options to purchase 294,360266,500 shares of common stock remained outstanding under the 2011 Plan.

Stock-based Compensation Expense

General and administrative (“G&A”) and research and development (“R&D”) expenses include non-cash stock-based compensation expense as a result of our issuance of stock options. The terms and vesting schedules for stock-based awards vary by type of grant and the employment status of the grantee. The awards granted through June 30, 20182019 vest based upon time-based and performance conditions. We expect to record additional non-cashThere was approximately $0.6 million unamortized stock-based compensation expense in the future, which may be significant.related to options granted to employees and non-employees as of June 30, 2019.

Stock-based compensation expense for each of the periods presented is as follows (in thousands):

A summary of stock option activity for the six months ended June 30, 2019 is as follows:

Information about stock options outstanding, vested and expected to vest as of June 30, 2018,2019, is as follows: