Note 3 – Fair Value Measurements

FASB ASC Topic 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions.

The three levels of the fair value hierarchy are as follows:

Level 1 – Quoted prices for identical instruments in active markets.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 – Instruments with primarily unobservable value drivers.

There were no transfers between Level 1, Level 2 and Level 3 during fiscal 2024 and 2023.

Amounts capitalized as IPR&D are subject to impairment testing until the completion or abandonment of the associated research and development efforts. We use probability-adjusted discounted cash flow calculations using Level 3 fair value measurements and inputs including estimated revenues, costs, probability of technical and regulatory success and discount rates to measure impairment, if any. During the second quarter of fiscal 2023, we recognized an impairment charge of $3.9 million associated with IPR&D intangible assets due to their meeting the criteria for abandonment under the accounting standards. See Note 8 for additional information.

As of September 30, 2024 and 2023, the Company’s financial liabilities measured at fair value on a recurring basis, which consisted of embedded derivatives, are also classified within Level 3 of the fair value hierarchy.

The Company determines the fair value of hybrid instruments based on available market data using appropriate valuation models, considering all of the rights and obligations of each instrument. The Company estimates the fair value of hybrid instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective of measuring fair value. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. Estimating the fair value of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Increases in fair value during a given financial quarter result in the recognition of non-cash derivative expense. Conversely, decreases in fair value during a given financial quarter would result in the recognition of non-cash derivative income. 

The following table provides a reconciliation of the beginning and ending liability balance associated with embedded derivatives measured at fair value using significant unobservable inputs (Level 3) for the years ended September 30, 2024 and 2023:

The expense or income associated with the change in fair value of the embedded derivatives is presented as a separate line item in the accompanying consolidated statements of operations.

The liabilities associated with embedded derivatives represent the fair value of the change of control provisions in the Residual Royalty Agreement. See Note 9 for additional information. There is no current observable market for these types of derivatives. The Company estimates the fair value of the embedded derivative within the Residual Royalty Agreement by using a scenario-based method, whereby different scenarios are valued and probability weighted. The scenario-based valuation model incorporates transaction details such as the contractual terms of the instrument and assumptions including projected FC2 revenues, expected cash outflows, probability and estimated dates of a change of control, risk-free interest rates and applicable credit risk. Material changes in any of these inputs could result in a significantly higher or lower fair value measurement at future reporting dates, which could have a material effect on our results of operations. The increase in the fair value of derivative liabilities in fiscal 2024 was driven by an increase in the probability of a change of control and decreases in the discount rates used, due primarily to external market factors. The decrease in the fair value of derivative liabilities in fiscal 2023 was driven by a decrease in the expected cash outflows under the Residual Royalty Agreement, due to decreases in projected FC2 net revenues in future periods, and increases in the discount rates used, due primarily to external market factors.

The following table presents quantitative information about the inputs and valuation methodologies used to determine the fair value of the embedded derivatives classified in Level 3 of the fair value hierarchy as of September 30, 2024 and 2023:

The Company also has an investment in equity securities consisting of 142,749 shares of ONCO Common Stock. The Company received 3,000 shares of Series A Convertible Preferred Stock (the “ONCO Preferred Stock”) of ONCO on October 3, 2023 as part of a settlement of the receivable due on September 30, 2023 related to the sale of ENTADFI. See Note 15 for additional information. The Company elected to measure the ONCO Preferred Stock at fair value in accordance with ASC 825. The investment in the ONCO Preferred Stock was classified within Level 3 of the fair value hierarchy because there is no market for the ONCO Preferred Stock and the fair value was determined using significant unobservable inputs. The fair value of the ONCO Preferred Stock was determined on the date received using a probability-weighted bond plus call option model, which incorporated the stock price of ONCO on the valuation date, expected volatility of 79%, expected term of 3 years, and a discount rate of 35%. The Company also applied a 15% discount for lack of marketability due to the fact that there is no market for the preferred stock and a 60% probability of dissolution. The valuation was determined to be $0.9 million at October 3, 2023.

On September 24, 2024, the Company converted all of the shares of ONCO Preferred Stock it holds into 142,749 shares of ONCO Common Stock. Following this conversion, the ONCO Common Stock is classified within Level 1 of the fair value hierarchy and the valuation is determined based on the closing price of the ONCO Common Stock. The value of the ONCO Common Stock is $0.7 million as of September 30, 2024, which is included in prepaid expenses and other current assets on the accompanying consolidated balance sheet, and the Company recognized a loss from the change in fair value of securities of $0.2 million during the year ended September 30, 2024 on the accompanying consolidated statement of operations. Subsequent to September 30, 2024, the Company sold all of the shares of ONCO Common Stock it held for net proceeds of $0.4 million.