Annual report pursuant to Section 13 and 15(d)

Fair Value Measurements

Fair Value Measurements

12 Months Ended

Dec. 31, 2019

ASC No. 820, Fair Value Measurements and Disclosures (“ASC 820”) defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value standard also establishes a three‑level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels are defined as follows:


•	Level 1—inputs to the valuation methodology are quoted prices (unadjusted) for an identical asset or liability in an active market.


•	Level 2—inputs to the valuation methodology include quoted prices for a similar asset or liability in an active market or model‑derived valuations in which all significant inputs are observable for substantially the full term of the asset or liability.


•	Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability.

The following table presents, for each of the fair value hierarchy levels required under ASC 820, the Company’s assets and liabilities from continuing operations that are measured at fair value on a recurring basis:



	December 31, 2019
	Fair Value Measurements Using
	Quoted prices in		Significant other		Significant
	active markets for		observable		unobservable
	identical assets		inputs		inputs
	(Level 1)		(Level 2)		(Level 3)
Assets
Investments in money market funds*	$	2,240,230	$	—	$	—
Investment in Aytu	$	—	$	7,628,947	$	—
Liabilities
Warrant liability**	$	—	$	—	$	3,460
Unit purchase option liability**	$	—	$	—	$	10,594



	December 31, 2018
	Fair Value Measurements Using
	Quoted prices in		Significant other		Significant
	active markets for		observable		unobservable
	identical assets		inputs		inputs
	(Level 1)		(Level 2)		(Level 3)
Assets
Investments in money market funds*	$	7,324,932	$	—	$	—
Liabilities
Contingent consideration	$	—	$	—	$	1,256,210
Warrant liability**	$	—	$	—	$	2,950
Unit purchase option liability**	$	—	$	—	$	7,216

*Investments in money market funds are reflected in cash and cash equivalents on the accompanying consolidated balance sheets.

**Warrant liability and unit purchase option liability are reflected in accrued expenses and other current liabilities on the accompanying consolidated balance sheets.

As of December 31, 2019 and 2018, the Company’s financial instruments included cash and cash equivalents, restricted cash, accounts receivable, other receivables, accounts payable, accrued expenses and other current liabilities, warrant liability, the underwriters' unit purchase option liability and contingent consideration. The carrying amounts reported in the accompanying consolidated financial statements for cash and cash equivalents, restricted cash, accounts receivable, other receivables, accounts payable, accrued expenses and other current liabilities approximate their respective fair values because of the short-term nature of these accounts.

Level 2 Valuation

The table presented below is a summary of changes in fair value of the Company's Level 2 valuation for the Investment in Aytu for the year ended December 31, 2019:



	Investment in
	Aytu
Balance at December 31, 2018	$	—
Initial valuation of Investment in Aytu upon issuance of Aytu Preferred Stock	7,575,015
Change in fair value of Investment in Aytu	53,932
Balance at December 31, 2019	$	7,628,947

As part of the consideration for the Aytu Divestiture, Aytu issued to Cerecor 9,805,845 shares of Aytu Series G Convertible Preferred Stock (the "Aytu Series G Preferred Stock" or "Aytu Preferred Stock") at a price of $1.2747 per share, which, pursuant to the Aytu Purchase Agreement, represents a formula averaging the volume weighted average price of Aytu's common stock for the 30-day period ending immediately prior to August 30, 2019 and the 30-day period ending on October 28, 2019. The Aytu Series G Preferred Stock is not transferable until July 1, 2020. Further, the Aytu Series G Preferred Stock becomes convertible at the option of Cerecor and solely in connection with either (i) the distribution of the underlying shares of common stock issuable upon conversion to Cerecor’s stockholders; or (ii) the sale of the underlying shares of common stock issuable upon conversion in open market broker transactions or private sales to unaffiliated third parties. The Aytu Series G Preferred Stock is similar to Aytu's common stock other than it has no voting rights, is subject to a lock-up period and is only convertible to common stock in certain circumstances. Additionally, the Aytu Series G Preferred Stock was restricted as of December 31, 2019.

Upon closing of the Aytu Divestiture on November 1, 2019, the Company recognized $7.6 million as the estimated fair value of the Aytu Series G Preferred Stock on that date. The fair value as of November 1, 2019 was calculated using Aytu's stock price close on November 1, 2019 of $1.03 per share and offset by an estimated discount for lack of marketability of 25% calculated using guideline public company volatility for comparable companies.

Subsequent to the initial measurement, at each reporting period, the Investment in Aytu will be remeasured at the current fair value with the change in fair value recorded to other income, net in the accompanying statements of operations. As of December 31, 2019, the Investment of Aytu was $7.6 million, representing an immaterial change from the initial measurement on November 1, 2019. The fair value as of December 31, 2019 was calculated using Aytu's closing stock price on December 31, 2019 of $0.9725 per share and offset by an estimated discount for lack of marketability of 20% calculated using guideline public company volatility for comparable companies. The Investment in Aytu is recorded in the consolidated balance sheet as a current asset because the Aytu Series G Preferred Stock is available for sale within one year of December 31, 2019. Subsequent to December 31, 2019, Aytu's common stock price has been volatile and therefore Cerecor may recognize a significant gain or loss on the change in fair value of the Investment in Aytu for the three months ending March 31, 2020 and any future reporting period based on actual movements in the underlying stock price.

Level 3 Valuation

The tables presented below are a summary of changes in the fair value of the Company’s Level 3 valuations for the warrant liability, unit purchase option liability and contingent consideration from continuing operations for the years ended December 31, 2019 and 2018:



	Warrant		Unit purchase		Contingent
	liability		option liability		consideration			Total
Balance at December 31, 2018	$	2,950	$	7,216	$	1,256,211		$	1,266,377
Change in fair value due to Lachlan Settlement	—		—		(1,277,150		)	(1,277,150		)
Change in fair value	510		3,378		20,939			24,827
Balance at December 31, 2019	$	3,460	$	10,594	$	—		$	14,054



	Warrant			Unit purchase			Contingent
	liability			option liability			consideration			Total
Balance at December 31, 2017	$	8,185		$	26,991		$	2,577,134		$	2,612,310
Purchase price allocation measurement period adjustment of contingent consideration	—			—			(1,210,000		)	(1,210,000		)
Change in fair value	(5,235		)	(19,775		)	(110,923		)	(135,933		)
Balance at December 31, 2018	$	2,950		$	7,216		$	1,256,211		$	1,266,377

In 2014, the Company issued warrants to purchase 625,208 shares of convertible preferred stock. Upon the closing of the Company's initial public offering ("IPO") in October 2015, these warrants became warrants to purchase 22,328 shares of common stock, in accordance with their terms. The warrants expire in October 2020. The warrants represent a freestanding financial instrument that is indexed to an obligation, which the Company refers to as the warrant liability. The warrant liability is marked-to-market each reporting period with the change in fair value recorded to other income, net in the accompanying statements of operations until the warrants are exercised, expire or other facts and circumstances lead the warrant liability to be reclassified to stockholders’ equity. The fair value of the warrant liability is estimated using a Black-Scholes option-pricing model. The significant assumptions used in preparing the option pricing model for valuing the warrant liability as of December 31, 2019, include (i) volatility of 42%, (ii) risk-free interest rate of 1.59%, (iii) strike price of $8.40, (iv) fair value of common stock of $5.39, and (v) expected life of 0.8 years.

The underwriters’ unit purchase option (the “UPO”) was issued to the underwriters of the Company's IPO in 2015 and provides the underwriters the option to purchase up to a total of 40,000 units. The units underlying the UPO will be, immediately upon exercise, separated into shares of common stock, underwriters’ Class A warrants and underwriters’ Class B warrants (such warrants together referred to as the Underwriters’ Warrants). The Underwriters’ Warrants are warrants to purchase shares of common stock. The Class B warrants expired in April 2017 and the Class A warrants expired in October 2018, while the UPO expires in October 2020. The Company classifies the UPO as a liability as it is a freestanding marked-to-market derivative instrument that is precluded from being classified in stockholders’ equity. The UPO liability is marked-to-market each reporting period with the change in fair value recorded to other income, net in the accompanying statements of operations until the UPO is exercised, expires or other facts and circumstances lead the UPO to be reclassified to stockholders’ equity. The fair value of the UPO liability is estimated using a Black-Scholes option-pricing model. The significant assumptions used in preparing the simulation model for valuing the UPO as of December 31, 2019, include (i) volatility of 42%, (ii) risk-free interest rate of 1.59%, (iii) unit strike price of $7.47, (iv) fair value of underlying equity of $5.39, and (v) expected life of 0.8 years.

The Company's business acquisitions of Avadel's pediatric products and TRx (see Note 5) involved the potential for future payment of consideration that is contingent upon the achievement of operational and commercial milestones and royalty payments on future product sales. The fair value of contingent consideration was determined at the acquisition date utilizing unobservable inputs such as the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liabilities are remeasured at the current fair value with changes recorded in the consolidated statement of operations.

Prior to the close of the Aytu Divestiture on November 1, 2019, the Company was required to pay a 15% annual royalty on net sales of the acquired Avadel pediatric products through February 2026 up to an aggregate amount of $12.5 million. The fair value of the future royalty was the expected future value of the contingent payments discounted to a present value. As detailed in Note 3, in connection with the close of the Aytu Divestiture on November 1, 2019, the contingent consideration related to Avadel's pediatric products was assumed by Aytu. Therefore, as of December 31, 2019, no value was assigned to the contingent consideration as of December 31, 2019. On November 1, 2019, in conjunction with the closing of the Aytu Divestiture, the Company entered into a Guarantee which guarantees the payment by Aytu of the contingent consideration related to future potential royalties on Avadel's pediatric products. For additional information regarding the Guarantee, which is recorded within discontinued operations, see Note 3.

The consideration for the TRx Acquisition included certain potential contingent payments. First, pursuant to the TRx Purchase Agreement, the Company was required to pay $3.0 million to the TRx Sellers upon the gross profit related to TRx products achieving or exceeding a gross profit of $12.6 million in 2018. The Company did not achieve this contingent event in 2018 and therefore no value was assigned to the contingent payout for the year ended December 31, 2018. Additionally, the Company was required to pay the following: (1) $2.0 million upon the transfer of the Ulesfia NDA to the Company ("NDA Transfer Milestone"), and (2) $2.0 million upon FDA approval of a new dosage of Ulesfia ("FDA Approval Milestone"). However, as part of the settlement the Company entered into during the second quarter of 2019 with Lachlan Pharmaceuticals, an Irish company controlled by the previous owners of TRx, among additional terms discussed in Note 16, the Company gave up its right to sell Ulesfia, except for a limited amount of inventory on hand until that inventory is sold or expired. As a result, the settlement released the Company from the potential contingent payments related to the NDA Transfer Milestone and FDA Approval Milestone and therefore, no value was assigned to the two milestones as of December 31, 2019 resulting in the Company recognizing a gain on the change of fair value of contingent consideration of $1.3 million for the year ended December 31, 2019.

Additionally, as a result of the Aytu Divestiture, the Company performed a non-recurring Level 3 valuation to assign goodwill to the disposed Pediatric Portfolio using the relative fair value approach (see Note 3 and Note 10 for more detail). The Company also recognized impairment of $1.4 million for the year ended December 31,2019 due to the impairment of the Flexichamber asset, which is considered a non-recurring Level 3 valuation. As Flexichamber was a part of the Aytu Divestiture, the impairment expense was included in income (loss) from discontinued operations, net of tax (inclusive of gain on sale) for the year ended December 31, 2019 (see Note 3 and Note 5 for more detail).

No other changes in valuation techniques or inputs occurred during the years ended December 31, 2019 and 2018. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the years ended December 31, 2019 and 2018.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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