derm-10q_20190630.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to           

Commission File Number 001-36668

 

DERMIRA, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

27-3267680

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

275 Middlefield Road, Suite 150

Menlo Park, CA 94025

(Address of principal executive offices) (Zip Code)

(650) 421-7200

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Common Stock, $0.001 par value

Trading symbol

 

DERM

Name of each exchange on which registered

 

The Nasdaq Global Select Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes      No  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes     No 

As of July 31, 2019, the registrant had 54,397,955 shares of common stock outstanding.

 

 

 


Table of Contents

 

Dermira, Inc.

Quarterly Report on Form 10-Q

Index

 

 

Page

No.

PART I

FINANCIAL INFORMATION

 

 

 

 

ITEM 1:

Financial Statements

3

 

Condensed Consolidated Balance Sheets

3

 

Condensed Consolidated Statements of Operations

4

 

Condensed Consolidated Statements of Comprehensive Loss

5

 

Condensed Consolidated Statements of Stockholders’ Equity (Deficit)

6

 

Condensed Consolidated Statements of Cash Flows

7

 

Notes to Condensed Consolidated Financial Statements

8

ITEM 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

ITEM 3:

Quantitative and Qualitative Disclosures About Market Risk

32

ITEM 4:

Controls and Procedures

32

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

ITEM 1:

Legal Proceedings

33

ITEM 1A:

Risk Factors

33

ITEM 2:

Unregistered Sales of Equity Securities and Use of Proceeds

70

ITEM 3:

Defaults Upon Senior Securities

70

ITEM 4:

Mine Safety Disclosures

70

ITEM 5:

Other Information

70

ITEM 6:

Exhibits

71

 

 

 

Signatures

72

 

 

2


Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

DERMIRA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 

June 30,

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

103,155

 

 

$

104,976

 

Short-term investments

 

 

222,014

 

 

 

208,064

 

Trade and other receivables, net

 

 

59,795

 

 

 

5,724

 

Inventory

 

 

17,644

 

 

 

8,370

 

Prepaid expenses and other current assets

 

 

25,862

 

 

 

8,275

 

Total current assets

 

 

428,470

 

 

 

335,409

 

Property and equipment, net

 

 

864

 

 

 

1,180

 

Long-term investments

 

 

1,997

 

 

 

2,962

 

Operating lease right-of-use asset

 

 

13,144

 

 

 

 

Intangible assets

 

 

903

 

 

 

952

 

Goodwill

 

 

771

 

 

 

771

 

Restricted cash

 

 

804

 

 

 

802

 

Other assets

 

 

313

 

 

 

2,245

 

Total assets

 

$

447,266

 

 

$

344,321

 

Liabilities and stockholders’ equity (deficit)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

11,549

 

 

$

15,948

 

Accrued liabilities

 

 

20,029

 

 

 

22,608

 

Lease liability, current

 

 

4,220

 

 

 

 

Deferred revenue, current

 

 

15,075

 

 

 

 

Total current liabilities

 

 

50,873

 

 

 

38,556

 

Long-term liabilities:

 

 

 

 

 

 

 

 

Term loan

 

 

32,731

 

 

 

32,566

 

Convertible notes, net

 

 

282,145

 

 

 

281,223

 

Lease liability, non-current

 

 

9,621

 

 

 

 

Deferred revenue, non-current

 

 

6,340

 

 

 

 

Other long-term liabilities

 

 

 

 

 

1,015

 

Total liabilities

 

 

381,710

 

 

 

353,360

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

Common stock

 

 

54

 

 

 

42

 

Additional paid-in capital

 

 

893,221

 

 

 

736,095

 

Accumulated other comprehensive income (loss)

 

 

113

 

 

 

(138

)

Accumulated deficit

 

 

(827,832

)

 

 

(745,038

)

Total stockholders’ equity (deficit)

 

 

65,556

 

 

 

(9,039

)

Total liabilities and stockholders’ equity (deficit)

 

$

447,266

 

 

$

344,321

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales

 

$

8,060

 

 

$

 

 

$

10,512

 

 

$

 

Collaboration and license revenue

 

 

58,585

 

 

 

39,080

 

 

 

58,585

 

 

 

39,379

 

Total revenue

 

 

66,645

 

 

 

39,080

 

 

 

69,097

 

 

 

39,379

 

Costs and operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

1,335

 

 

 

 

 

 

2,261

 

 

 

 

Research and development

 

 

18,285

 

 

 

19,545

 

 

 

33,854

 

 

 

45,136

 

Selling, general and administrative

 

 

63,327

 

 

 

40,770

 

 

 

112,006

 

 

 

71,280

 

Impairment of intangible assets

 

 

 

 

 

 

 

 

 

 

 

1,126

 

Total costs and operating expenses

 

 

82,947

 

 

 

60,315

 

 

 

148,121

 

 

 

117,542

 

Loss from operations

 

 

(16,302

)

 

 

(21,235

)

 

 

(79,024

)

 

 

(78,163

)

Interest and other income, net

 

 

1,970

 

 

 

2,037

 

 

 

3,521

 

 

 

3,771

 

Interest expense

 

 

(3,630

)

 

 

(4,734

)

 

 

(7,291

)

 

 

(8,988

)

Loss before taxes

 

 

(17,962

)

 

 

(23,932

)

 

 

(82,794

)

 

 

(83,380

)

Benefit for income taxes

 

 

 

 

 

 

 

 

 

 

 

194

 

Net loss

 

$

(17,962

)

 

$

(23,932

)

 

$

(82,794

)

 

$

(83,186

)

Net loss per share, basic and diluted

 

$

(0.33

)

 

$

(0.57

)

 

$

(1.70

)

 

$

(1.99

)

Weighted-average common shares used to compute net loss per share, basic and diluted

 

 

54,033

 

 

 

41,922

 

 

 

48,838

 

 

 

41,875

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

4


Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Net loss

 

$

(17,962

)

 

$

(23,932

)

 

$

(82,794

)

 

$

(83,186

)

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on available-for-sale securities

 

 

82

 

 

 

173

 

 

 

251

 

 

 

45

 

Total comprehensive loss

 

$

(17,880

)

 

$

(23,759

)

 

$

(82,543

)

 

$

(83,141

)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

5


Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands)

(unaudited)

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

 

 

Accumulated

Other

Comprehensive

 

 

Accumulated

 

 

Total

Stockholders’

Equity

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

 

 

Gain (Loss)

 

 

Deficit

 

 

(Deficit)

 

Balance at December 31, 2018

 

 

42,328

 

 

$

42

 

 

$

736,095

 

 

 

 

$

(138

)

 

$

(745,038

)

 

$

(9,039

)

Issuance of common stock in connection with public offering, net of underwriting discounts, commissions and issuance costs of $9,318

 

 

11,283

 

 

 

12

 

 

 

140,171

 

 

 

 

 

 

 

 

 

 

 

140,183

 

Issuance of common stock upon restricted stock unit settlement, net of shares withheld for taxes

 

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

 

13

 

 

 

 

 

 

23

 

 

 

 

 

 

 

 

 

 

 

23

 

Stock-based compensation

 

 

 

 

 

 

 

 

8,090

 

 

 

 

 

 

 

 

 

 

 

8,090

 

Unrealized gain on investments

 

 

 

 

 

 

 

 

 

 

 

 

 

169

 

 

 

 

 

 

169

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(64,832

)

 

 

(64,832

)

Balance at March 31, 2019

 

 

53,633

 

 

$

54

 

 

$

884,379

 

 

 

 

$

31

 

 

$

(809,870

)

 

$

74,594

 

Issuance of common stock upon restricted stock unit settlement, net of shares withheld for taxes

 

 

503

 

 

 

 

 

 

(490

)

 

 

 

 

 

 

 

 

 

 

(490

)

Exercise of stock options

 

 

96

 

 

 

 

 

 

382

 

 

 

 

 

 

 

 

 

 

 

382

 

Purchases under employee stock purchase plan

 

 

166

 

 

 

 

 

 

1,371

 

 

 

 

 

 

 

 

 

 

 

1,371

 

Stock-based compensation

 

 

 

 

 

 

 

 

7,579

 

 

 

 

 

 

 

 

 

 

 

7,579

 

Unrealized gain on investments

 

 

 

 

 

 

 

 

 

 

 

 

 

82

 

 

 

 

 

 

82

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(17,962

)

 

 

(17,962

)

Balance at June 30, 2019

 

 

54,398

 

 

$

54

 

 

$

893,221

 

 

 

 

$

113

 

 

$

(827,832

)

 

$

65,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

 

 

Accumulated

Other

Comprehensive

 

 

Accumulated

 

 

Total

Stockholders’

Equity

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

 

 

Gain (Loss)

 

 

Deficit

 

 

(Deficit)

 

Balance at December 31, 2017

 

 

41,798

 

 

$

42

 

 

$

703,215

 

 

 

 

$

(215

)

 

$

(553,393

)

 

$

149,649

 

Issuance of common stock upon restricted stock unit settlement, net of shares withheld for taxes

 

 

6

 

 

 

-

 

 

 

-

 

 

 

 

 

-

 

 

 

-

 

 

 

-

 

Exercise of stock options

 

 

44

 

 

 

-

 

 

 

197

 

 

 

 

 

-

 

 

 

-

 

 

 

197

 

Stock-based compensation

 

 

-

 

 

 

-

 

 

 

7,514

 

 

 

 

 

-

 

 

 

-

 

 

 

7,514

 

Unrealized loss on investments

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

(128

)

 

 

-

 

 

 

(128

)

Effect of adoption of the ASC 606

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

-

 

 

 

29,895

 

 

 

29,895

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

-

 

 

 

(59,254

)

 

 

(59,254

)

Balance at March 31, 2018

 

 

41,848

 

 

$

42

 

 

$

710,926

 

 

 

 

$

(343

)

 

$

(582,752

)

 

$

127,873

 

Issuance of common stock upon restricted stock unit settlement, net of shares withheld for taxes

 

 

21

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

 

37

 

 

 

 

 

 

73

 

 

 

 

 

 

 

 

 

 

 

73

 

Purchases under employee stock purchase plan

 

 

97

 

 

 

 

 

 

954

 

 

 

 

 

 

 

 

 

 

 

954

 

Stock-based compensation

 

 

 

 

 

 

 

 

7,306

 

 

 

 

 

 

 

 

 

 

 

7,306

 

Unrealized gain on investments

 

 

 

 

 

 

 

 

 

 

 

 

 

173

 

 

 

 

 

 

173

 

Effect of adoption of the ASC 606

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(23,932

)

 

 

(23,932

)

Balance at June 30, 2018

 

 

42,003

 

 

$

42

 

 

$

719,259

 

 

 

 

$

(170

)

 

$

(606,684

)

 

$

112,447

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6


Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(82,794

)

 

$

(83,186

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

294

 

 

 

244

 

Stock-based compensation

 

 

15,491

 

 

 

14,820

 

Amortization of discount for payments related to acquired in-process research and development

 

 

 

 

 

3,760

 

Net (accretion) amortization of premiums on available-for-sale securities

 

 

(1,265

)

 

 

357

 

Amortization of debt discount and issuance costs

 

 

1,087

 

 

 

916

 

Amortization of operating lease right-of-use assets

 

 

1,645

 

 

 

 

Impairment of intangible assets

 

 

 

 

 

1,126

 

Loss on disposal of assets

 

 

101

 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Trade and other receivables, net

 

 

(54,071

)

 

 

(4

)

Inventory

 

 

(9,095

)

 

 

(102

)

Prepaid expenses and other current assets

 

 

(17,691

)

 

 

(3,707

)

Other assets

 

 

1,932

 

 

 

(543

)

Accounts payable

 

 

(4,315

)

 

 

(2,697

)

Accrued liabilities

 

 

(1,821

)

 

 

(1,238

)

Refund liability

 

 

 

 

 

(7,180

)

Other long-term liabilities

 

 

 

 

 

128

 

Lease liabilities

 

 

(1,700

)

 

 

 

Deferred revenue

 

 

21,415

 

 

 

(379

)

Deferred taxes

 

 

 

 

 

(194

)

Net cash used in operating activities

 

 

(130,787

)

 

 

(77,879

)

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(163,822

)

 

 

(233,001

)

Maturities of available-for-sale securities

 

 

152,060

 

 

 

190,615

 

Purchase of property and equipment

 

 

(30

)

 

 

(574

)

Net cash used in investing activities

 

 

(11,792

)

 

 

(42,960

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Net proceeds from issuance of common stock in connection with equity financings

 

 

140,170

 

 

 

 

Payments for debt issuance cost

 

 

(708

)

 

 

 

Net proceeds from issuance of common stock in connection with equity awards

 

 

1,298

 

 

 

1,224

 

Net cash provided by financing activities

 

 

140,760

 

 

 

1,224

 

Net decrease in cash and cash equivalents and restricted cash

 

 

(1,819

)

 

 

(119,615

)

Cash and cash equivalents and restricted cash at beginning of year

 

 

105,778

 

 

 

296,723

 

Cash and cash equivalents and restricted cash at end of period

 

$

103,959

 

 

$

177,108

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

7


Table of Contents

 

DERMIRA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Organization

We are a biopharmaceutical company dedicated to bringing biotech ingenuity to medical dermatology by delivering differentiated, new therapies to the millions of patients living with chronic skin conditions. We are committed to understanding the needs of both patients and physicians and using our insight to identify, develop and commercialize leading-edge medical dermatology products. Our approved treatment, QBREXZA™ (glycopyrronium) cloth (“QBREXZA”), is indicated for adult and pediatric patients (ages nine and older) with primary axillary hyperhidrosis (excessive underarm sweating). We are evaluating lebrikizumab for the treatment of moderate-to-severe atopic dermatitis (a severe form of eczema) and plan to initiate a Phase 3 clinical development program by the end of 2019. We also have early-stage research and development programs in other areas of dermatology. We are headquartered in Menlo Park, California.

 

2. Summary of Significant Accounting Policies

Basis of Presentation

Our condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules and regulations, certain footnotes or other financial information normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements have been prepared on the same basis as our annual consolidated financial statements and, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of our financial information. The results of operations for the three- and six-month periods ended June 30, 2019 are not necessarily indicative of the results to be expected for the full year ending December 31, 2019 or any other future period. The condensed consolidated balance sheet as of December 31, 2018 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

The accompanying condensed consolidated financial statements include the accounts of our wholly owned subsidiary, Dermira Canada. All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with our audited consolidated financial statements and the related notes thereto for the year ended December 31, 2018 included in our Annual Report on Form 10-K, filed with the SEC on February 26, 2019.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and variable consideration, inventory, acquired in-process research and development, investments, accrued research and development expenses, goodwill, operating lease assets and liabilities, intangible assets, other long-lived assets, stock-based compensation and the valuation of deferred tax assets. We base our estimates on our historical experience and also on assumptions that we believe are reasonable; however, actual results could significantly differ from those estimates.

Restricted Cash

Restricted cash primarily consists of letters of credit collateralized by a money market account pursuant to certain lease and sublease agreements.

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Concentration of Credit Risk

Financial instruments that potentially subject us to a concentration of credit risk consist primarily of cash and cash equivalents, investments and trade and other receivables. We invest in money market funds, U.S. Treasury securities, corporate debt, repurchase agreements, U.S. Government agency securities, commercial paper and certificates of deposits. Bank deposits are held primarily by a limited number of financial institutions and these deposits may exceed insured limits. We are exposed to credit risk in the event of a default by the financial institutions holding our cash and cash equivalents and issuers of investments to the extent recorded on the consolidated balance sheets. Our investment policy limits investments to money market funds, certain types of debt securities issued by the U.S. Government and its agencies, corporate debt, repurchase agreements, commercial paper, certificates of deposit and municipal bonds and places restrictions on the credit ratings, maturities and concentration by type and issuer.

As of and for the three and six months ended June 30, 2019, three customers (AmerisourceBergen Corporation, McKesson Corporation and Cardinal Health, Inc.) each accounted for more than 10% of our trade receivables and product sales. These three customers collectively accounted for 97.5% and 96.7% of product sales for the three and six months ended June 30, 2019, respectively, and 99.1% of our trade receivables as of June 30, 2019. As of June 30, 2019, we have a receivable of $50.0 million from Almirall, S.A. (“Almirall”), which was recorded in trade and other receivables, net.

Trade and Other Receivables

Our trade receivables consist of amounts due from the sale of QBREXZA. The trade receivables are recorded net of allowances for distribution fees and trade discounts, government rebates and chargebacks. Estimates for wholesaler chargebacks for government rebates and cash discounts are based on contractual terms, historical trends and our expectations regarding the utilization rates for these programs. For the periods presented, we did not have any write-offs of trade receivables. We perform ongoing credit evaluations of our Customers and generally do not require collateral.

Other receivables, including collaboration and license receivables, are typically unsecured. Accordingly, we may be exposed to credit risk generally associated with our collaboration and license agreements. To date, we have not experienced any losses related to these receivables.

Inventory

Inventory consists of raw materials, work-in-process and finished goods related to the production of QBREXZA. Inventory costs are determined using the lower of standard cost, which approximates the actual costs determined using the first-in, first-out basis, or net realizable value. Standard costs are reviewed and updated annually or as needed. We expense costs associated with the manufacture of our products prior to regulatory approval and capitalize the cost of inventory when there is a high probability of future economic benefit. We began capitalizing the cost of inventory related to QBREXZA in the second quarter of 2018, the period in which we received regulatory approval to market the product. We expense costs associated with the manufacture of our lebrikizumab product candidate.

We review all inventory balances on a quarterly basis for impairment and recognize any reduction in value as a current period expense with a reserve provision on the condensed consolidated balance sheets. We write down inventory that is in excess of expected requirements or at risk of expiration. This assessment requires management to utilize judgment in formulating estimates and assumptions that we believe to be reasonable under the circumstances. Actual results may differ from those estimates and assumptions. If the conditions that caused the impairment were to be resolved in a subsequent period, the reserve provision would not be reversed until the related inventory was sold or otherwise disposed. As of June 30, 2019, the carrying value of our inventory was $17.6 million, including finished goods inventory of $5.6 million which has fixed expiration dates. In addition, we have manufacturing purchase commitments during the next 12 months of $11.0 million related to QBREXZA. In order to realize the value of our recorded inventory, we will be dependent upon significant increases in the sales volumes of QBREXZA.

Leases

We adopted Accounting Standards Update (“ASU”) No. 2016‑02, Leases (Topic 842) (“Topic 842”) on January 1, 2019. For our long-term operating leases, we recognized a right-of-use asset and a lease liability on our condensed consolidated balance sheets. The lease liability is determined as the present value of future lease payments using an estimated rate of interest that we would pay to borrow equivalent funds on a collateralized basis at the lease commencement date. As our leases do not provide an implicit rate, we estimated the rate of interest. In order to estimate the interest rate, we utilized the effective interest rate derived from recent debt transactions, adjusting it for factors that reflect the profile of secured borrowing over the expected term of the lease, including our credit rating. The right-of-use asset is based on the liability adjusted for any prepaid or deferred rent. We determined the lease term at the commencement date by considering whether renewal options and termination options are reasonably assured of exercise.

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We elected the practical expedients permitted under Topic 842, which allowed us to exclude from our condensed consolidated balance sheets recognition of leases having a term of 12 months or less (short-term leases) and we elected to not separate lease components and non-lease components for our long-term real-estate leases.

Rent expense for the operating lease is recognized on a straight-line basis over the lease term and is included in operating expenses on the condensed consolidated statements of operations. Variable lease payments include lease operating expenses.

Prior period amounts continue to be reported in accordance with our historic accounting under previous lease guidance, ASC 840, Leases (Topic 840) (“Topic 840”). See “―Recent Accounting Pronouncements” below, for more information about the impact of the adoption on Topic 842.

Revenue Recognition

We recognize revenue when we transfer promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To determine revenue recognition for contracts with customers we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy the performance obligations. At contract inception, we assess the goods or services promised within each contract and assess whether each promised good or service is distinct and determine those that are performance obligations. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Product Sales

Our product sales consist of sales of QBREXZA, which became available in pharmacies within the United States on October 1, 2018. We recognize revenue from product sales when our wholesalers and a preferred dispensing partner (together, “Customers”) obtain control of our product, which is generally upon delivery.

Product sales are recognized at the transaction price, net of estimates of variable consideration, including commercial rebates, discounts related to a savings card program, distribution fees, trade discounts, government rebates and chargebacks and product returns. Variable consideration amounts are estimated at contract inception using the expected-value method and updated at the end of each reporting period as additional information becomes available. The amounts of variable consideration are included in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Estimates and assumptions are updated quarterly and if actual future results vary materially from estimates, we will record an adjustment, which could impact product sales and earnings in the period of adjustment.

The following items of variable consideration are recorded at the time of revenue recognition and require significant estimates and judgment.

Commercial rebates and savings card program. We contract with certain third-party payers for the payment of rebates with respect to the utilization of QBREXZA. Rebates to these payers are based on contractual percentages applied to the amount of QBREXZA prescribed to patients who are covered by the plan or the organization with which we have contracts. We estimate and record rebates as a reduction to the transaction price in the same period the related product sales are recognized. We estimate commercial rebates based on contractual terms, estimated payer mix, industry information and other third-party data. We also have a savings card program to provide assistance to eligible patients with out-of-pocket costs, such as deductibles, co-insurance and co-payments, for the patient’s usage of QBREXZA. Reductions to product sales for the savings card program are estimated based on actual and expected program utilization.

Distribution fees and trade discounts.  We pay our Customers certain fees for distribution services for QBREXZA. We have determined that such distribution services are not distinct from our sales of QBREXZA and the related fees are recorded as a reduction to the transaction price in the period the related product sales are recognized. Distribution fees are recorded based on contractual terms. We also incentivize prompt payment from our Customers by providing a discount for payments made within a certain number of days.

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Government rebates and chargebacks.  We are subject to discount obligations under state Medicaid programs, Medicare and other government programs. Reserves for these rebates and chargebacks are recorded as a reduction to the transaction price in the period the related product sales are recognized. Chargeback amounts represent credit we expect to issue to our Customers and are recorded as a reduction to trade and other receivables, net. Reductions to product sales for government managed programs are estimated based on statutorily-defined discounts, estimated payer mix, expected sales to qualified healthcare providers and expected utilization.

Product returns.  Our product return policy provides our Customers the right to return QBREXZA, generally based on the product expiration date. The reserve for product returns is recorded as a reduction to the transaction price in the period the related product sales are recognized. We estimate product returns using third-party input and market data for products with characteristics similar to QBREXZA.

As of June 30, 2019, the balance of our revenue-related reserves, consisting of commercial rebates, discounts related to the savings card program, distribution fees, trade discounts, government rebates, chargebacks and product returns, was $3.5 million, of which $1.2 million was recorded as a direct deduction from trade and other receivables and $2.3 million was recorded in accrued liabilities on the condensed consolidated balance sheets. As of December 31, 2018, the balance of these revenue-related reserves was $2.5 million, of which $0.7 million was recorded as a direct deduction from trade and other receivables and $1.8 million was recorded in accrued liabilities on the condensed consolidated balance sheets. During the three and six months ended June 30, 2019, additions to the revenue-related reserves were $5.2 million and $12.9 million, respectively, which were offset by related credits or payments of $5.1 million and $11.9 million, respectively. We had no additions or credits to the revenue-related reserve during the three and six months ended June 30, 2018.

Collaborative Arrangements

We enter into collaborative arrangements that typically include one of more of the following: (i) license fees; (ii) milestone payments related to the achievement of developmental, regulatory, or commercial goals; (iii) royalties on net sales of licensed products; and (iv) fees attributable to options to intellectual property. When a portion of non‑refundable up-front fees or other payments received are allocated to continuing performance obligations under the terms of a collaborative arrangement, they are recorded as deferred revenue and recognized as revenue when (or as) the underlying performance obligation is satisfied. Fees attributable to options are deferred until the option expires or is exercised. When an option is exercised, the performance obligations associated with the option are identified, which will determine the accounting for the transaction price attributable to the option.

As part of the accounting for these arrangements, we must develop estimates and assumptions that require judgment to determine the underlying stand-alone selling price for each performance obligation which determines how the transaction price is allocated among the performance obligation. The stand-alone selling price may include items such as forecasted revenues, development timelines, discount rates, and probabilities of technical and regulatory success. We evaluate each performance obligation to determine if it can be satisfied at a point in time or over time. In addition, variable consideration must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

Under certain collaborative arrangements, we have been reimbursed for a portion of our research and development (“R&D”) expenses, including costs of drug supplies. When these R&D services are performed under a reimbursement or cost sharing model with our collaboration partner, we record these reimbursements as a reduction of R&D expense in our consolidated statements of operations.

License Fees

If a license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue. We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

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Milestone Payments

At the inception of each arrangement that includes milestone payments (variable consideration), we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our or our collaboration partner’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration or other revenues and earnings in the period of adjustment.

Royalties

For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and for which the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any royalty revenue resulting from any of our collaborative arrangements.

Advertising Expenses

We expense the costs of advertising as incurred. Advertising expenses were $26.7 million and $14.6 million for the three months ended June 30, 2019 and 2018, respectively, and $36.2 million and $21.5 million for the six months ended June 30, 2019 and 2018, respectively.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, without consideration for dilutive potential shares of common stock. Diluted net loss per share is the same as basic net loss per share, since the effects of potentially dilutive securities are antidilutive for all periods presented.

The following common stock equivalent shares were not included in the computations of diluted net loss per share for the periods presented because their effect was antidilutive (in thousands):

 

 

Outstanding as of June 30,

 

 

 

2019

 

 

2018

 

Stock options to purchase common stock

 

 

7,424

 

 

 

7,374

 

Shares subject to outstanding restricted stock units

 

 

1,953

 

 

 

1,544

 

Estimated shares issuable under the employee stock purchase plan

 

 

610

 

 

 

446

 

Shares issuable upon conversion of convertible notes

 

 

8,110

 

 

 

8,110

 

 

 

 

18,097

 

 

 

17,474

 

 

Recent Accounting Pronouncements

In November 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606 (“ASU 2018-18”), which clarified the interaction between Topic 808, Collaborative Arrangements, and Topic 606, Revenue from Contracts with Customers (“Topic 606”). ASU 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of adopting ASU 2018-18.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amended certain disclosure requirements over Level 1, Level 2 and Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of adopting ASU 2018-13, but do not anticipate it will have a material impact on our disclosures.

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In February 2016, the FASB issued Topic 842, which is aimed at making leasing activities more transparent and comparable, and requires lessees to recognize substantially all leases on their balance sheet as a right-of-use asset and a corresponding lease liability, including leases currently accounted for as operating leases. We adopted Topic 842 on January 1, 2019 using the modified retrospective approach. There was no cumulative-effect adjustment as of January 1, 2019. We recognized a right-of-use asset and a lease liability on our consolidated balance sheet for the discounted value of future lease payments from the adoption of Topic 842. The impact on the condensed consolidated balance sheets as of January 1, 2019 was as follows (in thousands):

 

 

 

Topic 840

 

 

Topic 842

 

 

Impact of

 

Balance Sheet

 

January 1, 2019

 

 

January 1, 2019

 

 

Adoption

 

Deferred rent classified as accrued liabilities

 

$

(134

)

 

$

 

 

$

134

 

Deferred rent classified as other long-term liabilities

 

 

(1,015

)

 

 

 

 

 

1,015

 

Operating lease right-of-use asset

 

 

 

 

 

14,788

 

 

 

14,788

 

Lease liability, current

 

 

 

 

 

(4,551

)

 

 

(4,551

)

Lease liability, non-current

 

$

 

 

$

(11,386

)

 

$

(11,386

)

 

 

3. Fair Value Measurements

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 on the measurement date. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. The accounting guidance for fair value establishes a three-level hierarchy for disclosure of fair value measurements, as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2—Inputs (other than quoted market prices included in Level 1) that are either directly or indirectly observable, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the instrument’s anticipated life.

Level 3—Unobservable inputs that are supported by little or no market activity and reflect our best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Where quoted prices are available in an active market, securities are classified as Level 1. When quoted market prices are not available for the specific security, then we estimate fair value by using quoted prices for identical or similar instruments in markets that are not active and model‑based valuation techniques for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets. Where applicable, these models project future cash flows and discount the future amounts to a present value using market‑based observable inputs obtained from various third‑party data providers, including but not limited to benchmark yields, reported trades and broker/dealer quotes. There were no transfers between Level 1 and Level 2 during the periods presented.

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The following tables set forth the fair value of our financial assets, which consists of investments classified as available-for-sale securities, that were measured on a recurring basis (in thousands):

 

 

 

 

As of June 30, 2019

 

 

 

Fair Value Hierarchy Level

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

Level 1

 

$

23,200

 

 

$

 

 

$

 

 

$

23,200

 

U.S. Treasury securities

 

Level 1

 

 

63,336

 

 

 

57

 

 

 

 

 

 

63,393

 

Corporate debt

 

Level 2

 

 

71,701

 

 

 

56

 

 

 

(7

)

 

 

71,750

 

U.S. Government agency securities

 

Level 2

 

 

14,997