1. Organization and Basis of Presentation

Nature of Operations

Agile Therapeutics, Inc. (the “Company”) was incorporated in Delaware on December 22, 1997. The Company is engaged in research and development of transdermal patch technology for use in contraception. The Company’s activities since inception have consisted principally of raising capital, and performing research and development. The Company is headquartered in Princeton, New Jersey.

The Company is devoting substantially all of its efforts toward research and development of its transdermal patch for use in contraception, and raising capital. The Company has not generated product revenue to date and is subject to a number of risks similar to those of other early stage companies, including dependence on key individuals, the difficulties inherent in the development of commercially usable products, the potential need to obtain additional capital necessary to fund the development of its products, and competition from larger companies. The Company has incurred losses each year since inception. As of June 30, 2015, the Company had an accumulated deficit of approximately $151.4 million.

The Company has financed its operations to date primarily through the issuance and sale of its common stock in its initial public offering (see Note 7), private placements of its common stock and convertible preferred stock, venture loans, and non-dilutive grant funding. The Company expects to continue to incur net losses into the foreseeable future.

Basis of Presentation

The accompanying unaudited interim condensed financial statements  have been prepared by the Company, without audit, in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. These interim condensed financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2014 filed with the SEC.

In the opinion of management, the unaudited interim condensed financial statements reflects all adjustments, which are normal recurring adjustments, necessary for the fair presentation of the financial information for the interim periods have been made. The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the operating results for the full fiscal year or any future period.

2. Summary of Significant Accounting Polices

The Company’s complete listing of significant accounting policies are described in Note 2 to the Company’s audited financial statements as of December 31, 2014 included in its annual report on Form 10-K filed with the SEC.

Use of Estimates

The preparation of the Company’s financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company bases its estimates and judgments on historical experience and various other assumptions that it believes are reasonable under the circumstances. The amounts of assets and liabilities reported in the Company’s balance sheets and the amounts of expenses reported for each of the periods presented are affected by estimates and assumptions, which are used for, but not limited to, the accounting for common stock warrants, stock-based compensation, income taxes, and accounting for research and development costs. Actual results could differ from those estimates.

Fair Value of Financial Instruments

In accordance with ASC 825, Financial Instruments, disclosures of fair value information about financial instruments are required, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. Cash and cash equivalents are carried at fair value (see Note 3).

Financial instruments, including accounts payable and accrued liabilities, are carried at cost, which approximates fair value given their short-term nature.

Warrants

The Company accounts for its warrants to purchase redeemable convertible stock in accordance with ASC 480, Distinguishing Liabilities from Equity. ASC 480 requires that a financial instrument, other than outstanding share, that, at inception, is indexed to an obligation to repurchase the issuer’s equity shares, regardless of the timing or the probability of the redemption feature, and may require the issuer to settle the obligation by transferring assets be classified as a liability. The Company measures the fair value of its warrant liability using an option pricing model with changes in fair value recognized as increases or reductions to other income (expense) in the statement of operations.

In connection with the completion of the Company’s initial public offering in May 2014, the warrants to purchase shares of Series A-1 and Series A-2 preferred stock expired unexercised and the warrants to purchase shares of Series C preferred stock automatically converted into warrants to purchase shares of common stock.  Warrants with non-standard anti-dilution provisions (referred to as down round protection) are classified as liabilities and re-measured each reporting period.

The warrants issued in connection with the Company’s debt financing completed in February 2015 (see Note 6) are classified as a component of stockholders’ equity.  The value of such warrants was determined using the Black-Scholes option-pricing model.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 718, Compensation-Stock Compensation. The Company grants stock options for a fixed number of shares to employees and non-employees with an exercise price equal to the fair value of the shares at grant date. Compensation cost is recognized for all share-based payments granted and is based on the grant- date fair value estimated using the weighted-average assumption of the Black- Scholes option pricing model based on key assumptions such as stock price, expected volatility and expected term. The equity instrument is not considered to be issued until the instrument vests. As a result, compensation cost is recognized over the requisite service period with an offsetting credit to additional paid-in capital.

Awards for consultants are accounted for under ASC 505-50, Equity Based Payments to Non-Employees. Any compensation expense related to consultants is marked-to-market over the applicable vesting period as they vest.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding plus the effect of dilutive potential common shares outstanding during the period determined using the treasury-stock and if-converted methods. For purposes of diluted net loss per share calculation, convertible preferred stock, convertible preferred stock warrants, common stock warrants and stock options are considered to be potentially dilutive securities but are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive and therefore, basic and diluted net loss per share were the same for all periods presented.

Potentially dilutive securities that have been excluded from the calculation of diluted net loss per share for the three and six months ended June 30, 2015 and 2014 because to do so would be anti-dilutive are as follows (in common equivalent shares):

Recent Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board (FASB) issued an amendment to U.S. GAAP to simplify the balance sheet presentation of the costs for issuing debt.  The changes were adopted in Accounting Standards Update (ASU) No. 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issue Costs.  Public companies will have to apply the amendments for reporting periods that begin after December 15, 2015.  This amendment requires adoption by revising the balance sheets for periods prior to the effective date.  The Company is currently evaluating the impact of this ASU and does not believe the adoption of this ASU will have a material impact on the Company’s financial position or results of operations.

3. Fair Value Measurements

ASC 820, Fair Value Measurements and Disclosures, describes the fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Assets and liabilities that are measured at fair value are reported using a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

The Company is required to mark the value of its warrant liability to market and recognize the change in valuation in its statements of operations each reporting period.

The following table sets forth the Company’s financial instruments measured at fair value by level within the fair value hierarchy as of June 30, 2015 and December 31, 2014.

The significant assumptions used in preparing the option pricing model for valuing the Company’s warrants as of June 30, 2015 include (i) volatility (75.0%), (ii) risk free interest rate of 1.63% (estimated using treasury bonds with a 4.50 year life), (iii) strike price ($6.00) for the common stock warrants, (iv) fair value of common stock ($8.59) and (v) expected life (4.50 years).

The following is a rollforward of the fair value of Level 3 warrants:

The significant assumptions used in preparing the option pricing model for valuing the Company’s warrants as of December 31, 2014 include (i) volatility (104.8%), (ii) risk free interest rate of 1.68% (estimated using treasury bonds with a 5 year life), (iii) strike price ($6.00) for the common stock warrants, (iv) fair value of common stock ($6.14) and (v) expected life (five years).

There were no transfers between Level 1, 2 or 3 during 2014 or 2015. If the Company’s estimates regarding the fair value of its warrants are inaccurate, a future adjustment to these estimated fair values may be required. Additionally, these estimated fair values could change significantly.

4. Prepaid Expenses

Prepaid expenses consist of the following:

Prepaid expenses, long-term represents non-refundable advances to the Company’s clinical research organization which will be applied against final invoices in accordance with the contractual terms of the arrangement.

5. Accrued Liabilities

Accrued liabilities consist of the following:

6. Loan and Security Agreements

Oxford Finance LLC

In December 2012, the Company entered into a Loan and Security Agreement (the “Oxford Loan”) with Oxford Finance LLC (“Oxford”) pursuant to which the Company borrowed a total of $15.0 million from Oxford. The Oxford Loan accrued interest at a fixed annual rate equal to 9.20% (three-month U.S. Libor rate of 0.47% plus 8.73%).

Interest on the Oxford Loan was payable monthly and principal was due in 30 equal consecutive monthly installments beginning on February 1, 2015 and ending on July 1, 2017.  In addition, the Company was required to make a final payment of $675,000 on the maturity date of the Oxford Loan (July 1, 2017).

In February 2015, the Company terminated and repaid all amounts outstanding under the Oxford Loan and recorded a loss on the extinguishment of the Oxford Loan (see further discussion below).

Hercules Technology Growth Capital, Inc.

In February 2015, the Company entered into a loan and security agreement (the “Hercules Loan”) with Hercules Technology Growth Capital, Inc. (“Hercules”) for a term loan of up to $25.0 million.  A first tranche of $16.5 million was funded upon execution of the Hercules Loan, approximately $15.5 million of which was used to repay the Company’s existing term loan with Oxford.  The Company is scheduled to make interest only payments on the loan until July 1, 2016, which period may be extended under certain circumstances.  Under the terms of the Hercules Loan, the Company may, but is not obligated to, draw an additional tranche of up to $8.5 million prior to July 1, 2016, subject to the achievement of certain clinical milestones, which may be extended to December 31, 2016 under certain circumstances.

The Hercules Loan accrues interest at a rate of the greater of 9.0% or 9.0% plus Prime minus 4.25% and is payable monthly.  Principal is due in 30 equal consecutive monthly installments beginning on July 1, 2016 and ending on December 1, 2018.  In addition, the Company is required to make a final payment of $610,500 on the maturity date of the Hercules Loan (December 1, 2018).

The Company may prepay all, but not less than all, of the Hercules Loan subject to a prepayment premium of 3.0% of the outstanding principal if prepaid during the first year, 2.0% of the outstanding principal if prepaid during the second year and 1.0% of the outstanding principal if prepaid after the second year. The obligations of the Company under the Hercules Loan are secured by a perfected first position lien on all of the assets of the Company, excluding intellectual property assets.

In connection with the Hercules Loan, the Company issued Hercules a warrant to purchase 180,274 shares of the Company’s common stock at an exercise price of $5.89 per share and granted Hercules the right to participate in future equity financings in an amount up to $2.0 million while the loan and warrant are outstanding.

The Company allocated the proceeds of $16.5 million in accordance with ASC 470 based on the relative fair values.  The relative fair value of the warrants of approximately $1.2 million at the time of issuance, which was determined using the Black-Scholes option-pricing model, was recorded as additional paid-in capital and reduced the carrying value of the debt.  The discount on the debt is being amortized to interest expense over the term of the debt.

As a result of the repayment of the Oxford Loan, the Company recorded a loss on the extinguishment of debt of approximately $1.0 million on the Company’s statement of operations for the six months ended June 30, 2015, representing a prepayment premium, the unamortized discount of the Oxford Loan and the write off of deferred financing costs.

7. Stockholders’ Equity

Initial Public Offering and Related Transactions

On May 29, 2014, the Company completed its initial public offering selling 9,166,667 shares of common stock at $6.00 per share.  Proceeds from the Company’s initial public offering, net of underwriting discounts and commissions and other offering costs, were $49.7 million.

In addition, each of the following occurred in connection with the completion of the Company’s IPO on May 29, 2014:

Private Placement

In January 2015, the Company completed a private placement of approximately 3.4 million shares of common stock at $5.85 per share.  Proceeds from the Company’s private placement, net of commissions and other offering costs, were approximately $19.3 million.

Shelf Registration Statement

On June 19, 2015, the Company filed a universal shelf registration statement with the SEC for the issuance of common stock, preferred stock, warrants, rights, debt securities and units up to an aggregate amount of $150.0 million (the “2015 Shelf Registration Statement”).  On July 1, 2015, the 2015 Shelf Registration Statement was declared effective by the SEC.  In the future, the Company may periodically offer one or more of these securities in amounts, prices and terms to be announced when and if the securities are offered.  At the time any of the securities covered by the 2015 Shelf Registration Statement are offered for sale, a prospectus supplement will be prepared and filed with the SEC containing specific information about the terms of any such offering.

Stock-Based Compensation Expense

Stock-based compensation expense related to stock options was allocated as follows:

8. Income Taxes

Sale of New Jersey Net Operating Losses

The Company received approval to sell a portion of the Company’s New Jersey net operating losses (NOLs) as part of the Technology Business Tax Certificate Program sponsored by The New Jersey Economic Development Authority. Under the program, emerging biotechnology companies with unused NOLs and unused research and development credits are allowed to sell these benefits to other companies. On February 27, 2014, the Company completed the sale of NOLs totaling approximately $39.1 million for net proceeds of approximately $3.6 million. Such proceeds are reflected as a tax benefit for six months ended June 30, 2014.

9. Related Party Transactions

Effective March 17, 2014, one of the Managing Partners of SmartPharma LLC or SmartPharma, an entity which provides commercial and business development consulting services to the Company was appointed Chief Commercial Officer. In connection with the appointment of this individual as Chief Commercial Officer, the Company amended its consulting agreement with SmartPharma to remove this individual from the list of persons providing service under the consulting agreement. SmartPharma invoiced the Company $18,050 and $44,150 of fees for the three and six months ended June 30, 2015, respectively, and $3,250 and $74,300 of fees for the three and six months ended June 30, 2014, respectively.

Use of Estimates

The preparation of the Company’s financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company bases its estimates and judgments on historical experience and various other assumptions that it believes are reasonable under the circumstances. The amounts of assets and liabilities reported in the Company’s balance sheets and the amounts of expenses reported for each of the periods presented are affected by estimates and assumptions, which are used for, but not limited to, the accounting for common stock warrants, stock-based compensation, income taxes, and accounting for research and development costs. Actual results could differ from those estimates.

Warrants

The Company accounts for its warrants to purchase redeemable convertible stock in accordance with ASC 480, Distinguishing Liabilities from Equity. ASC 480 requires that a financial instrument, other than outstanding share, that, at inception, is indexed to an obligation to repurchase the issuer’s equity shares, regardless of the timing or the probability of the redemption feature, and may require the issuer to settle the obligation by transferring assets be classified as a liability. The Company measures the fair value of its warrant liability using an option pricing model with changes in fair value recognized as increases or reductions to other income (expense) in the statement of operations.

In connection with the completion of the Company’s initial public offering in May 2014, the warrants to purchase shares of Series A-1 and Series A-2 preferred stock expired unexercised and the warrants to purchase shares of Series C preferred stock automatically converted into warrants to purchase shares of common stock.  Warrants with non-standard anti-dilution provisions (referred to as down round protection) are classified as liabilities and re-measured each reporting period.

The warrants issued in connection with the Company’s debt financing completed in February 2015 (see Note 6) are classified as a component of stockholders’ equity.  The value of such warrants was determined using the Black-Scholes option-pricing model.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding plus the effect of dilutive potential common shares outstanding during the period determined using the treasury-stock and if-converted methods. For purposes of diluted net loss per share calculation, convertible preferred stock, convertible preferred stock warrants, common stock warrants and stock options are considered to be potentially dilutive securities but are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive and therefore, basic and diluted net loss per share were the same for all periods presented.

Potentially dilutive securities that have been excluded from the calculation of diluted net loss per share for the three and six months ended June 30, 2015 and 2014 because to do so would be anti-dilutive are as follows (in common equivalent shares):

Potentially dilutive securities that have been excluded from the calculation of diluted net loss per share for the three and six months ended June 30, 2015 and 2014 because to do so would be anti-dilutive are as follows (in common equivalent shares):