Emmaus Life Sciences, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

3 Months Ended

Mar. 31, 2020

The Company is a commercial-stage biopharmaceutical company engaged in the discovery, development, marketing and sales of innovative treatments and therapies primarily for rare and orphan diseases. On July 17, 2019, we completed a merger transaction with EMI Holding, Inc., formerly known as Emmaus Life Sciences, Inc. (“EMI”), into a subsidiary of the Company (the “Merger”), with EMI surviving the Merger as a wholly owned subsidiary. Immediately after completion of the Merger, we changed our name to “Emmaus Life Sciences, Inc.”

The Merger was treated as a reverse recapitalization under the acquisition method of accounting in accordance with accounting principles generally accepted in the U.S. For accounting purposed, EMI was considered to have acquired us. The Merger is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes.

In connection with and prior to the Merger, we contributed and transferred to Telemynd, Inc. (“Telemynd”), a newly formed, wholly owned subsidiary of the Company, all or substantially all our historical business, assets and liabilities and our board of directors declared a stock dividend of one share of the Telemynd common stock held by the Company for each outstanding share of our common stock after giving effect to a 1-for-6 reverse stock split of our outstanding shares of common stock.

As a result of the spin-off and the Merger, our ongoing business became EMI’s business, which is that of a commercial-stage biopharmaceutical company focused on the development, marketing and sale of innovative treatments and therapies, including those in the rare and orphan disease categories.

Principles of consolidation

Principles of consolidation—The consolidated financial statements include the accounts of the Company, EMI and EMI’s wholly‑owned subsidiary, Emmaus Medical, Inc., and Emmaus Medical, Inc.’s wholly‑owned subsidiaries. All significant intercompany transactions have been eliminated.

The preparation of the consolidated financial statements requires the use of management estimates that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses for the reported period. Actual results could differ materially from those estimates.

Restatement of Prior Period Amounts

Restatement of Prior Period Amounts — In connection with the preparation of our December 31, 2019 consolidated financial statements, we identified the following material errors in our condensed consolidated financial statements as of and for the three months ended March 31, 2019.

The misclassification as equity of warrants issued by EMI in October of 2018, which warrants should have been accounted for as liabilities based upon fair value; and

The erroneous consolidation as a variable interest entity, or VIE, of EMI’s interest in EJ Holdings, Inc., which should have been accounted for based upon the equity method.

The mistreatment of the fair value of cashless exercise warrants originally recorded in the Consolidated Statements of Operations and Comprehensive Loss, which fair value should have been recorded in additional paid-in capital in the

Consolidated Balance Sheets.

In addition to the errors described above, the restated financial statements also include adjustments to correct certain immaterial errors identified during the audit of the Company’s financial statements for the year ended December 31, 2019.

EMMAUS LIFE SCIENCES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

	As of March 31, 2019
	Previously Reported			Adjustment				Restated
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	15,310		$	(13,070	)	(a)	$	2,240
Accounts receivable, net		1,760			301		(c)		2,061
Inventories, net		5,795			—				5,795
Investment in marketable securities		42,873			—				42,873
Marketable securities, pledged to creditor		251			—				251
Prepaid expenses and other current assets		818			(215	)	(a), (c)		603
Total current assets		66,807			(12,984	)			53,823
Property and equipment, net		153			—				153
Long-term investment at cost		527			—				527
Equity method investment		—			13,470		(a)		13,470
Right of use assets		2,838			—				2,838
Deposits and other assets		410			—				410
Total assets	$	70,735		$	486			$	71,221
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	11,068		$	(371	)	(a), (c)	$	10,697
Operating lease liabilities, current portion		682			—				682
Other current liabilities		5,217			75		(c)		5,292
Warrant derivative liabilities		—			9,877		(b), (c)		9,877
Notes payable, net of discount		7,000			806		(b)		7,806
Notes payable to related parties		470			—				470
Convertible notes payable, net of discount		15,157			—				15,157
Convertible notes payable to related parties, net of discount		13,896			—				13,896
Total current liabilities		53,490			10,387				63,877
Operating lease liabilities, less current portion		2,478			—				2,478
Other long-term liabilities		35,637			—				35,637
Warrant derivative liabilities		1,447			(1,447	)	(c)		—
Notes payable, net of discount, less current portion		1,922			(771	)	(b)		1,151
Convertible debentures, net of discount, less current portion		389			—				389
Total liabilities		95,363			8,169				103,532
STOCKHOLDERS’ DEFICIT
Preferred stock — par value $0.001 per share, 20,000,000 shares authorized, none issued or outstanding		—			—				—
Common stock — par value $0.001 per share, 250,000,000 shares authorized, 37,750,424 shares were issued and outstanding at March 31, 2019		36			2		(d)		38
Additional paid-in capital		146,344			10,164		(b), (e)		156,508
Accumulated other comprehensive income (loss)		(62	)		—				(62	)
Accumulated deficit		(170,864	)		(17,931	)	(e)		(188,795	)
Total stockholders’ deficit		(24,546	)		(7,765	)			(32,311	)
Noncontrolling interest		(82	)		82		(a)		—
Total liabilities & stockholders’ deficit	$	70,735		$	486			$	71,221

(a) EJ Holdings adjustments: the correction of this misstatement resulted in increases of $13.5 million in equity method investment, $114,000 in accounts payable and accrued expenses, and $82,000 in non-controlling interest and decreases of $13.1 million in cash and cash equivalent and $205,000 in prepaid expenses and other current assets.

(b) Warrant adjustments: the correction of this misstatement resulted in increases of $8.5 million in warrant derivative current liabilities and $806,000 in short-term note payable and decreases of $771,000 in long-term notes payable and $9.7 million in additional paid-in capital.

(c) Corrections of other misstatement: period adjustment and reclassification of variable consideration resulted in an increase of $301,000 in accounts receivable and a decrease of $486,000 in accounts payable and accrued expenses, a decrease of $10,000 in income tax receivable and an increase of $23,000 in income tax payable; a correction of accounting treatment for convertible notes resulted in an increase of $1.3 million in additional paid-in capital; a reclassification of GPB warrants resulted an increase of short-term warrant liabilities and a decrease of long-term warrant liabilities of $1.4 million; and a correction of tax provision resulted in an increase of $52,000 in income tax payable.

(d) Retrospective adjustments made to common stock resulted from recapitalization transaction in July 2019.

(e) Balance includes carryforward impact on 2018 restatement adjustments, including cashless warrant adjustments which resulted in an increase in additional paid-in capital and a decrease in retained earnings of $18.3 million.

EMMAUS LIFE SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except share and per share amounts)

(Unaudited)

	Three months ended March 31, 2019
	Previously Reported			Adjustment				Restated
REVENUES, NET	$	5,307		$	(600	)	(c)	$	4,707
COST OF GOODS SOLD		200			59		(c)		259
GROSS PROFIT	$	5,107		$	(659	)			4,448
OPERATING EXPENSES
Research and development		513			—				513
Selling		1,485			(6	)	(c)		1,479
General and administrative		3,681			56		(a), (c)		3,737
Total operating expenses		5,679			50				5,729
LOSS FROM OPERATIONS		(572	)		(709	)			(1,281	)
OTHER INCOME (EXPENSE)
Change in fair value of warrant derivative liabilities		(48	)		(890	)	(b)		(938	)
Net gains (losses) on equity investment in marketable securities		(6,457	)		—				(6,457	)
Gain on equity method investment		—			9		(a)		9
Interest and other income (loss)		(111	)		34		(a)		(77	)
Interest expense		(6,965	)		(1,647	)	(b), (c)		(8,612	)
Total other income (expenses)		(13,581	)		(2,494	)			(16,075	)
LOSS BEFORE INCOME TAXES		(14,153	)		(3,203	)			(17,356	)
INCOME TAXES		—			52		(c)		52
NET LOSS INCLUDING NONCONTROLLING INTERESTS		(14,153	)		(3,255	)			(17,408	)
Net (income) loss attributable to noncontrolling interest		(14	)		14		(a)		—
NET LOSS ATTRIBUTABLE TO THE COMPANY		(14,167	)		(3,241	)			(17,408	)

COMPONENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
Foreign currency translation adjustments		8			(1	)	(a)		7
Other comprehensive income (loss)		8			(1	)			7
COMPREHENSIVE INCOME (LOSS)		(14,145	)		(3,256	)			(17,401	)
Amounts attributable to noncontrolling interest:
Net (income) loss attributable to noncontrolling interest		(14	)		14		(a)		—
Foreign currency translation adjustments		(1	)		1		(a)		—
Comprehensive (income) loss attributable to noncontrolling interest		(15	)		15				—
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO THE COMPANY	$	(14,160	)	$	(3,241	)		$	(17,401	)
NET LOSS PER COMMON SHARE - BASIC AND DILUTED	$	(0.38	)	$	(0.09	)		$	(0.46	)
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING		37,473,431			—				37,473,431

(a) EJ Holdings adjustments: the correction of this misstatement resulted in increases of $55,000 in general and administrative expenses, $9,000 in loss on equity method investment and $34,000 in interest income and decreases of $14,000 in net income attributable to noncontrolling interest and $1,000 in foreign currency translation adjustments.

(b) Warrant adjustments: the correction of this misstatement resulted in an increase of $312,000 in interest expense and a decrease of $890,000 in change in fair value of warrant derivative liabilities.

(c) Corrections of other misstatements: period adjustment of variable consideration resulted in a decrease of $600,000 in revenues, net; reclassification of shipping cost and royalty expense to cost of sales resulted in an increase of $59,000 in cost of sales and decreases of $6,000 and $53,000 in selling expense and general and administrative expense, respectively; correction of stock modification accounting resulted in a decrease of $52,000 in general and administrative expense; correction of accounting treatment for convertible notes resulted in an increase of $1.3 million in interest expense; a correction of tax provision resulted in an increase of $52,000 in tax provision

EMMAUS LIFE SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Three months ended March 31,2019
	Previously Reported			Adjustment				Restated
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(14,153	)	$	(3,255	)		$	(17,408	)
Adjustments to reconcile net loss to net cash flows from operating activities
Depreciation and amortization		17			—				17
Amortization of discount of convertible notes		5,641			1,647		(b), (c)		7,288
Foreign exchange adjustments		(19	)		108				89
Net losses (gains) on equity investment in marketable securities		6,457			—				6,457
Gain on equity method investment		—			(9	)	(a)		(9	)
Share-based compensation		536			52		(c)		588
Change in fair value of warrant derivative liabilities		48			890		(a)		938
Net changes in operating assets and liabilities
Accounts receivable		(409	)		266				(143	)
Inventories		(1,091	)		—				(1,091	)
Prepaid expenses and other current assets		(83	)		(32	)			(115	)
Other non-current assets		(2,813	)		—				(2,813	)
Income tax		—			52				52
Accounts payable and accrued expenses		2,339			386				2,725
Deferred revenue		500			—				500
Deferred rent		(287	)		—				(287	)
Other current liabilities		36			—				36
Other long-term liabilities		1,997			—				1,997
Net cash flows (used in) provided by operating activities		(1,284	)		105				(1,179	)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment		(16	)		—				(16	)
Net cash flows used in investing activities		(16	)		—				(16	)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of convertible notes		(3,048	)		—				(3,048	)
Proceeds from exercise of warrants		5			—				5
Proceeds from issuance of common stock		2,530			—				2,530
Proceeds from conversion of notes payable to common stock		21			—				21
Net cash flows used in financing activities		(492	)		—				(492	)
Effect of exchange rate changes on cash		22			—				22
Net increase (decrease) in cash, cash equivalents and restricted cash		(1,770	)		105				(1,665	)
Cash and cash equivalents, beginning of period		17,080			(13,175	)			3,905
Cash and cash equivalents, end of period	$	15,310		$	(13,070	)		$	2,240
SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES
Interest paid	$	385		$	—			$	385
NON-CASH INVESTING AND FINANCING ACTIVITIES
Exercised of warrants and options on cashless basis	$	3,374		$	—			$	3,374
Conversion of notes payable to common stock	$	329		$	—			$	329
Initial recognition of right-of-use lease asset	$	2,922		$	—			$	2,922

Refer to the descriptions of the adjustments in the Condensed Consolidated Balance Sheets and Statements of Comprehensive Loss and their impact on net loss above. In addition, a cash flow classification adjustment related to EJ Holdings resulted in a net decrease to cash flows used by operating activities of $105,000.

Net loss per share

Net loss per share — In accordance with ASC 260, “Earnings per Share,” the basic loss per common share is computed by dividing net loss available to common stockholders by the weighted-average number of common shares outstanding. Dilutive loss per share is computed in a manner similar to basic loss per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. As of March 31, 2020 and March 31, 2019, the Company had outstanding potentially dilutive securities exercisable for or convertible into 16,698,829 shares and 17,995,514 shares, respectively, of the Company’s common stock. No potentially dilutive securities were included in the calculation of diluted net income per share since the potential dilutive securities were out of the money for the period ended March 31, 2020 and were anti-dilutive for period ended March 31, 2019.