Note 8 – Derivative Liability

The Company has entered into convertible note agreements containing beneficial conversion features and warrants.  The convertible notes include a ratchet reset provision which allows the note holders to reduce the conversion price should the Company issue equity with an effective price per share that is lower than the stated conversion price in the note agreement (see Note 9). The Company accounts for the fair value of this conversion feature in accordance with ASC 815, Accounting for Derivatives and Hedging and EITF 07-05, which provides that the embedded derivatives should be bundled and valued as a single, compound embedded derivative bifurcate treated as a derivative liability. The Company is required to carry the embedded derivative on its balance sheet at fair value and account for any unrealized change in fair value as a component in its results of operations.

The conversion feature embedded within these convertible notes is a financial derivative and GAAP requires that this embedded conversion option be accounted for at fair value.

During the three months ended February 28, 2019, the Company sold 1,425,641 shares of common stock and 712,820 two-year warrants to purchase one share of common stock at a price of $3.90 per share for total proceeds of $2,657,099, net of issuance costs. The warrant holders have an option to settle in cash in the event of a change of control of the Company. The Company considers these warrants a derivative liability, and calculated the fair value of this liability utilizing a lattice model that values the warrant based upon a probability weighted discounted cash flow model.

The following schedule shows the change in fair value of the derivative liabilities for the six months ended February 28, 2019:

The derivative liabilities incurred valued based upon the following assumptions and key inputs at February 28, 2019, November 30, 2018 and August 31, 2018:

The Company derivative warrants were fair valued as of issuance and as of February 28, 2019 with the following assumptions:

- The quoted stock price ranged from of $2.75 to $10.14 and would fluctuate with the Company historic volatility;

- The projected volatility curve from an annualized analysis for each valuation period was based on the historical volatility of the Company and the term remaining for each Warrant – the volatility ranged from 198-213%.

- The full reset events projected to occur based on future financing events on March 31, 2019 and December 31, 2019 resulting in a potential reset exercise price.

- Adjustments to warrants exercise prices have not occurred to date due to reset events.

- A fundamental transaction was projected to potentially occur on 4/30/19 or 12/31/19. The likelihood of such an event was estimated at 85% for the 4/30/19 event as of December/January 2019 increasing to 95% by 2/28/19. The 12/31/19 event was estimated at 50% for all dates.

- The option to force early exercise was estimated at 0% since it was unlikely that the Company would meet the registration and trading volume requirements necessary to trigger the option.