derm-10q_20190331.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 March 31, 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)

 

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 

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

As of April 30, 2019, the registrant had 53,667,718 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

20

ITEM 3:

Quantitative and Qualitative Disclosures About Market Risk

29

ITEM 4:

Controls and Procedures

29

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

ITEM 1:

Legal Proceedings

30

ITEM 1A:

Risk Factors

30

ITEM 2:

Unregistered Sales of Equity Securities and Use of Proceeds

67

ITEM 3:

Defaults Upon Senior Securities

67

ITEM 4:

Mine Safety Disclosures

67

ITEM 5:

Other Information

67

ITEM 6:

Exhibits

68

 

 

 

Signatures

69

 

 

2


Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

DERMIRA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 

March 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

201,693

 

 

$

104,976

 

Short-term investments

 

 

186,137

 

 

 

208,064

 

Trade and other receivables, net

 

 

8,450

 

 

 

5,724

 

Inventory

 

 

13,355

 

 

 

8,370

 

Prepaid expenses and other current assets

 

 

33,373

 

 

 

8,275

 

Total current assets

 

 

443,008

 

 

 

335,409

 

Property and equipment, net

 

 

964

 

 

 

1,180

 

Long-term investments

 

 

 

 

 

2,962

 

Operating lease right-of-use asset

 

 

13,978

 

 

 

 

Intangible assets

 

 

927

 

 

 

952

 

Goodwill

 

 

771

 

 

 

771

 

Restricted cash

 

 

803

 

 

 

802

 

Other assets

 

 

1,124

 

 

 

2,245

 

Total assets

 

$

461,575

 

 

$

344,321

 

Liabilities and stockholders’ equity (deficit)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

6,081

 

 

$

15,948

 

Accrued liabilities

 

 

21,826

 

 

 

22,608

 

Lease liability, current

 

 

4,187

 

 

 

 

Deferred revenue, current

 

 

30,000

 

 

 

 

Total current liabilities

 

 

62,094

 

 

 

38,556

 

Long-term liabilities:

 

 

 

 

 

 

 

 

Term loan

 

 

32,690

 

 

 

32,566

 

Convertible notes, net

 

 

281,684

 

 

 

281,223

 

Lease liability, non-current

 

 

10,513

 

 

 

 

Other long-term liabilities

 

 

 

 

 

1,015

 

Total liabilities

 

 

386,981

 

 

 

353,360

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

Common stock

 

 

54

 

 

 

42

 

Additional paid-in capital

 

 

884,379

 

 

 

736,095

 

Accumulated other comprehensive gain (loss)

 

 

31

 

 

 

(138

)

Accumulated deficit

 

 

(809,870

)

 

 

(745,038

)

Total stockholders’ equity (deficit)

 

 

74,594

 

 

 

(9,039

)

Total liabilities and stockholders’ equity (deficit)

 

$

461,575

 

 

$

344,321

 

 

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

 

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Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2019

 

 

2018

 

Revenue:

 

 

 

 

 

 

 

 

Product sales

 

$

2,452

 

 

$

 

Collaboration and license revenue

 

 

 

 

 

299

 

Total revenue

 

 

2,452

 

 

 

299

 

Costs and operating expenses:

 

 

 

 

 

 

 

 

Cost of sales

 

 

926

 

 

 

 

Research and development

 

 

15,569

 

 

 

25,591

 

Selling, general and administrative

 

 

48,679

 

 

 

30,510

 

Impairment of intangible assets

 

 

 

 

 

1,126

 

Total costs and operating expenses

 

 

65,174

 

 

 

57,227

 

Loss from operations

 

 

(62,722

)

 

 

(56,928

)

Interest and other income, net

 

 

1,551

 

 

 

1,734

 

Interest expense

 

 

(3,661

)

 

 

(4,254

)

Loss before taxes

 

 

(64,832

)

 

 

(59,448

)

Benefit for income taxes

 

 

 

 

 

194

 

Net loss

 

$

(64,832

)

 

$

(59,254

)

Net loss per share, basic and diluted

 

$

(1.49

)

 

$

(1.42

)

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

 

 

43,585

 

 

 

41,827

 

 

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

 

 

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DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2019

 

 

2018

 

Net loss

 

$

(64,832

)

 

$

(59,254

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

Unrealized gain (loss) on available-for-sale securities

 

 

169

 

 

 

(128

)

Total comprehensive loss

 

$

(64,663

)

 

$

(59,382

)

 

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

 

 

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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, 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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

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

 

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Table of Contents

 

DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(64,832

)

 

$

(59,254

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

150

 

 

 

115

 

Stock-based compensation

 

 

7,981

 

 

 

7,514

 

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

 

 

 

 

 

1,641

 

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

 

 

(583

)

 

 

280

 

Amortization of debt discount and issuance costs

 

 

585

 

 

 

458

 

Amortization of operating lease right-of-use assets

 

 

811

 

 

 

 

Impairment of intangible assets

 

 

 

 

 

1,126

 

Loss on disposal of assets

 

 

101

 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Trade and other receivables, net

 

 

(2,726

)

 

 

(5

)

Inventory

 

 

(4,876

)

 

 

 

Prepaid expenses and other current assets

 

 

(25,374

)

 

 

(507

)

Other assets

 

 

1,121

 

 

 

(648

)

Accounts payable

 

 

(9,873

)

 

 

(4,351

)

Accrued liabilities

 

 

(271

)

 

 

(809

)

Other long-term liabilities

 

 

 

 

 

141

 

Lease liabilities

 

 

(841

)

 

 

 

Deferred revenue

 

 

30,000

 

 

 

(299

)

Deferred taxes

 

 

 

 

 

(194

)

Net cash used in operating activities

 

 

(68,627

)

 

 

(54,792

)

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(43,189

)

 

 

(48,874

)

Maturities of available-for-sale securities

 

 

68,709

 

 

 

96,150

 

Purchase of property and equipment

 

 

(15

)

 

 

(35

)

Net cash provided by investing activities

 

 

25,505

 

 

 

47,241

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

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

 

 

140,525

 

 

 

 

Payments for debt issuance cost

 

 

(708

)

 

 

 

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

 

 

23

 

 

 

197

 

Net cash provided by financing activities

 

 

139,840

 

 

 

197

 

Net increase (decrease) in cash and cash equivalents and restricted cash

 

 

96,718

 

 

 

(7,354

)

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

 

$

202,496

 

 

$

289,369

 

 

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

 

 

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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, subject to an end-of-Phase 2 meeting with the U.S. Food and Drug Administration (“FDA”). We also have early-stage research and development programs in other areas of dermatology. We are headquartered in Menlo Park, California.

In March 2019, we sold 11,283,019 shares of our common stock in a public offering pursuant to a shelf registration statement on Form S-3 and received gross proceeds of $149.5 million and net proceeds of approximately $140.2 million, after deducting underwriting discounts and commissions of $9.0 million and offering expenses of approximately $0.3 million.

 

 

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-month period ended March 31, 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 receivables under our collaboration and license agreements. 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-month period ended March 31, 2019, three customers (AmerisourceBergen, McKesson and Cardinal Health) each accounted for more than 10% of our trade receivables and product sales. These three customers collectively accounted for 98.1% and 95.5% of our trade receivables and product sales, respectively, as of and for the three-month period ended March 31, 2019.

Trade 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.

Inventory

Inventories consist 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 are expensing 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 and 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 March 31, 2019, the carrying value of our inventory was $13.4 million, including finished goods inventory of $4.7 million which has fixed expiration dates. In addition, we have manufacturing purchase commitments during the next 12 months of $14.4 million. 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 the 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.

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.

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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.

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 within the United States. Following the approval of QBREXZA by the FDA in June 2018 and, in advance of the availability of QBREXZA in pharmacies on October 1, 2018, we commenced shipments of QBREXZA in September 2018 to wholesalers and a preferred dispensing partner (together, “Customers”) for distribution to pharmacies and patients. We recognize revenue from product sales when our 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 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.

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.

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Product returns.  Our product return policy provides our Customers the right to return QBREXZA, generally based on its 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 March 31, 2019, the balance of our revenue-related reserves, consisting of commercial rebates, savings card program, distribution fees, trade discounts, government rebates, chargebacks, and product returns, was $3.4 million, of which $1.0 million was recorded as a direct deduction from trade and other receivables and $2.4 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 months ended March 31, 2019, additions to the revenue-related reserves were $7.7 million, which was offset by related credits or payments of $6.8 million. We had no additions or credits to the revenue-related reserve during the three months ended March 31, 2018.

Collaborative Arrangements

We enter into collaborative arrangements with partners that typically include payment to us of 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. Where 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 to 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.

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.

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.

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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.

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.

Advertising Expenses

We expense the costs of advertising as incurred. Advertising expenses were $9.5 million and $6.9 million for the three months ended March 31, 2019 and March 31, 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 March 31,

 

 

 

2019

 

 

2018

 

Stock options to purchase common stock

 

 

7,744

 

 

 

7,387

 

Shares subject to outstanding restricted stock units

 

 

2,639

 

 

 

574

 

Estimated shares issuable under the employee stock purchase plan

 

 

602

 

 

 

193

 

Shares issuable upon conversion of convertible notes

 

 

8,110

 

 

 

8,110

 

 

 

 

19,095

 

 

 

16,264

 

 

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.

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 on the condensed consolidated statement of cash flows for the three months ended March 31, 2019 was as follows:

 

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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.

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 March 31, 2019

 

 

 

Fair Value Hierarchy Level

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

Level 1

 

$

10,782

 

 

$

 

 

$

 

 

$

10,782

 

U.S. Treasury securities

 

Level 1

 

 

75,192

 

 

 

27

 

 

 

(11

)

 

 

75,208

 

Corporate debt

 

Level 2

 

 

79,039

 

 

 

31

 

 

 

(17

)

 

 

79,053

 

U.S. Government agency securities

 

Level 2

 

 

1,991

 

 

 

1

 

 

 

 

 

 

1,992

 

Commercial paper

 

Level 2

 

 

66,469

 

 

 

 

 

 

 

 

 

66,469

 

Total investments

 

 

 

$

233,473

 

 

$

59

 

 

$

(28

)

 

$

233,504

 

 

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As of December 31, 2018

 

 

 

Fair Value Hierarchy Level

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

Level 1

 

$

21,201

 

 

$

 

 

$

 

 

$

21,201

 

U.S. Treasury securities

 

Level 1

 

 

84,098

 

 

 

5

 

 

 

(56

)

 

 

84,047

 

Corporate debt

 

Level 2

 

 

98,367

 

 

 

2

 

 

 

(88

)

 

 

98,281

 

U.S. Government agency securities

 

Level 2

 

 

1,984

 

 

 

 

 

(1

)

 

 

1,983

 

Commercial paper

 

Level 2

 

 

102,781

 

 

 

 

 

 

 

102,781

 

Total investments

 

 

 

$

308,431

 

 

$

7

 

 

$

(145

)

 

$

308,293

 

 

As of March 31, 2019, we did not hold any investments with a maturity exceeding one year or that have been in a continuous loss position for 12 months or more. We do not intend to sell the securities that are in an unrealized loss position and we believe it is more likely than not that the investments will be held until recovery of the amortized cost bases. We have determined that the gross unrealized losses on our securities as of March 31, 2019 were temporary in nature.

The estimated fair value of our term loan was $34.9 million as of March 31, 2019 and was based on interest rates currently available to us for debt with similar terms. The estimated fair value of our convertible notes was $254.3 million as of March 31, 2019 and was based upon observable, Level 2 inputs, including pricing information from recent trades of the convertible notes as of March 31, 2019.

 

 

4. Balance Sheet Components

Inventory

Inventory consists of the following (in thousands):

 

 

March 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

Raw materials

 

$

8,148

 

 

$

4,140

 

Work-in process

 

 

509

 

 

 

1,019

 

Finished goods

 

 

4,698

 

 

 

3,211

 

Total inventory

 

$

13,355

 

 

$

8,370

 

Accrued liabilities consist of the following (in thousands):

 

 

March 31,

 

 

December 31,

 

 

 

2019

 

 

2018

 

Accrued compensation

 

$

8,464

 

 

$

12,510

 

Accrued professional and consulting services

 

 

4,456

 

 

 

3,476

 

Accrued interest

 

 

3,258

 

 

 

1,102

 

Accrued outside research and development services

 

 

3,014

 

 

 

3,431

 

Other

 

 

2,634

 

 

 

2,089

 

Total accrued liabilities

 

$

21,826

 

 

$

22,608

 

 

5. Leases

 

We lease our corporate headquarters in Menlo Park, California under a non-cancelable operating lease agreement entered into in July 2014, as amended (“Lease”). Pursuant to the Lease, we lease 45,192 square feet of space in a multi-suite building (the “Building”). As of March 31, 2019, rent payments under the Lease include base rent with an annual increase of three percent, and additional monthly fees to cover our share of certain facility expenses, including utilities, property taxes, insurance and maintenance.

 

The Lease will expire on December 31, 2021, subject to our option to renew the Lease for an additional five-year term.

 

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Pursuant to the terms of the Lease, we provided the lessor with a $500,000 letter of credit in August 2014, which is collateralized by a money market account. The letter of credit may be used by or drawn upon by the lessor in the event of our default of certain terms of the Lease. If no such event of default has occurred or then exists, the letter of credit may be reduced to $350,000 after June 1, 2019. The collateralized money market account is restricted cash and recorded in our consolidated balance sheets in other assets.

In connection with the Lease, we recognized an operating lease right-of-use asset of $7.5 million and an aggregate lease liability of $8.2 million as of January 1, 2019 in our condensed consolidated balance sheet. The remaining Lease term is 3.0 years, and we used an estimated discount rate of 9.0% in calculating the lease liability.

 

In September 2017, we entered into a sublease agreement (“Sublease”) pursuant to which we expanded our office space by subleasing an additional 23,798 square feet of space in the Building. Rent payments for the Sublease include base rent with an annual increase of three percent, and additional monthly fees to cover our share of certain facility expenses, including utilities, property taxes, insurance and maintenance. The Sublease term commenced on December 20, 2017, and will end on April 30, 2024, unless terminated early pursuant to the terms of the Sublease.

 

Pursuant to the terms of the Sublease, in October 2017, we provided the sublessor with a $300,000 irrevocable commercial letter of credit, which is collateralized by a money market account. The letter of credit may be used by or drawn upon by the sublessor in the event of our default of certain terms of the Sublease. The collateralized money market account is restricted cash and recorded in our consolidated balance sheets in other assets.

In connection with the Sublease, we recognized an operating lease right-of-use asset of $7.2 million and an aggregate lease liability of $7.7 million as of January 1, 2019 in our condensed consolidated balance sheet. The remaining Sublease term is 5.3 years, and we used an estimated discount rate of 9.0% in calculating the lease liability.

 

Rent expense for the Lease and Sublease for the three months ended March 31, 2019 and 2018 was $1.6 million and $1.4 million, respectively, which includes additional rent charges for common area maintenance and real estate taxes of $0.4 million and $0.3 million, respectively. We recognize rent expense on a straight‑line basis over the lease period.

 

As of March 31, 2019, the undiscounted future non-cancellable lease payments under the Lease and Sublease were as follows (in thousands):

Year Ending December 31,

 

 

 

2019 (remainder)

$

3,187

 

2020

 

4,918

 

2021

 

5,056

 

2022

 

1,879

 

2023

 

1,936

 

Thereafter

 

666

 

Total undiscounted lease payments

 

17,642

 

Less: Present value adjustment

 

(2,942

)

Total

$

14,700

 

 

 

6. Debt

Credit Facility

In December 2018, we entered into a Credit Agreement (“Credit Agreement”) with Athyrium Opportunities III Acquisition LP. The arrangement provides for a senior secured term loan facility of up to $125.0 million in aggregate principal amount available in three tranches, $35.0 million of which was funded upon the closing. The second tranche of $40.0 million may be borrowed in a single draw at our option on or before July 1, 2019 and the third tranche of $50.0 million may be borrowed in a single draw on or before March 2, 2020 subject to a performance-based milestone. All loans under the facility bear interest at a rate of 10.75% per year, payable in quarterly in arrears, and provide for interest-only payments followed by payment of principal at maturity in December 2023; provided, however, that if, as of February 13, 2022, the aggregate outstanding principal amount of our 3.00% Convertible Senior Notes due 2022 (“Notes”) is greater than $60.0 million, we must immediately repay all amounts outstanding under the Credit Agreement, together with all accrued and unpaid interest and the applicable prepayment premium, if any. After the occurrence and

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during the continuation of a default, amounts outstanding will bear interest at a rate of 13.75% per annum, payable in cash quarterly in arrears and on demand. Our obligations under the Credit Agreement are secured by a security interest in, subject to certain exceptions, substantially all of our assets.

We may make voluntary prepayments in whole or in part, subject to certain prepayment premiums and additional interest payments. The Credit Agreement also contains certain provisions, such as default and change in control provisions, pursuant to which, if triggered, would require us to make mandatory prepayments on the term loan, which are subject to certain prepayment premiums and additional interest payments. We determined that these contingent prepayment provisions were an embedded component that qualified as a derivative which should be bifurcated from the term loan and accounted for separately from the host contract. As of March 31, 2019, the fair value of this embedded derivative was immaterial.

The Credit Agreement also contains representations and warranties and affirmative and negative covenants customary for financings of this type as well as customary events of default. As of March 31, 2019 and December 31, 2018, we were in compliance with all of the covenants under the Credit Agreement.

In connection with issuance of the term loan, we incurred certain costs and fees totaling $2.5 million which were recorded as a direct deduction discount from the term loan on the consolidated balance sheets and are being amortized ratably to interest expense over the term of the loan, using the effective interest method. As of March 31, 2019, there were unamortized issuance costs and debt discounts of $2.3 million related to the term loan. We recorded $1.0 million in interest expense related to the term loan for the three months ended March 31, 2019.

As of March 31, 2019, minimum aggregate future payments under the term loan are as follows (in thousands):

 

 

 

 

 

2019 (remaining nine months)

 

$

2,842

 

2020

 

 

3,763

 

2021

 

 

3,762

 

2022

 

 

3,763

 

2023

 

 

38,512

 

Total minimum payments

 

$

52,642

 

Amount representing interest

 

 

(17,642

)

Principal amount of term loan

 

$

35,000

 

 

Convertible notes

In May 2017, we sold $287.5 million aggregate principal amount of Notes in a private placement. We received net proceeds of $278.3 million, after deducting the initial purchasers’ discounts of $8.6 million and issuance costs of $0.6 million. The Notes were issued pursuant to an Indenture, dated as of May 16, 2017 (the “Indenture”), between us and U.S. Bank National Association, as trustee. The Notes are senior, unsecured obligations and bear interest at a rate of 3.00% per year, payable in cash semi-annually in arrears on May 15 and November 15 of each year, beginning on November 15, 2017. The Notes mature on May 15, 2022, unless earlier converted or repurchased in accordance with their terms.

The Notes are convertible into shares of our common stock, par value $0.001 per share, at an initial conversion rate of 28.2079 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $35.45 per share of common stock. The conversion rate and the corresponding conversion price are subject to adjustment upon the occurrence of certain events, but will not be adjusted for any accrued and unpaid interest. Holders of the Notes who convert their Notes in connection with a make-whole fundamental change (as defined in the Indenture) are, under certain circumstances, entitled to an increase in the conversion rate. Additionally, in the event of a fundamental change, holders of the Notes may require us to repurchase all or a portion of their Notes at a price equal to 100% of the principal amount of Notes, plus any accrued and unpaid interest, including any additional interest to, but excluding, the repurchase date. Holders of the Notes may convert all or a portion of their Notes at their option at any time prior to the close of business on the business day immediately prior to May 15, 2022, in multiples of $1,000 principal amount.

As of March 31, 2019, there were unamortized issuance costs and debt discounts of $5.8 million, which were recorded as a direct deduction from the Notes on the condensed consolidated balance sheets.

 

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7. Collaboration and License Agreements

In-license Agreements

Roche Agreement

In August 2017, we entered into a licensing agreement (“Roche Agreement”) with F. Hoffmann-La Roche Ltd and Genentech, Inc. (together, “Roche”), pursuant to which we obtained exclusive, worldwide rights to develop and commercialize lebrikizumab, an injectable, humanized antibody targeting interleukin 13, for atopic dermatitis and all other therapeutic indications. The Roche Agreement became effective in September 2017 upon the early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

Under the terms of the Roche Agreement, we made an initial payment of $80.0 million to Roche in October 2017 and a $25.0 million payment to Roche in July 2018 upon the achievement of 50% enrollment in our Phase 2 clinical study of lebrikizumab, which was achieved in June 2018, and a $30.0 million payment in November 2018 related to the achievement of 100% enrollment in our Phase 2 clinical study of lebrikizumab, which was achieved in October 2018. Under the original Roche Agreement, we were also obligated to make payments upon the achievement of certain milestones, including upon the initiation of the first Phase 3 clinical study, upon the achievement of regulatory and first commercial sale milestones in certain territories and based on the achievement of certain thresholds for net sales of lebrikizumab for all therapeutic indications. Upon regulatory approval, if obtained, we will make royalty payments representing percentages of net sales.

In February 2019, the Roche Agreement was amended to, among other things: (i) provide that Roche will supply us with up to approximately $16.0 million in existing lebrikizumab drug substance, free of charge; (ii) reduce our milestone payment obligation to Roche in connection with the initiation of our first Phase 3 clinical study of lebrikizumab from $40.0 million to $20.0 million; (iii) eliminate our milestone payment obligation to Roche upon the submission of the first application for regulatory approval of lebrikizumab in the United States, reducing the aggregate amount payable by us to Roche in connection with the submission of applications for regulatory approval of lebrikizumab in certain territories from $50.0 million to $20.0 million; and (iv) revise our obligation to make royalty payments representing percentages of tiers of annual net sales of lebrikizumab such that the percentages are increased but the range of percentages still begins in the high single-digits for the first annual net sales tier and ends in the high teens for annual net sales in excess of $3.0 billion. Accordingly, under the Roche Agreement, as amended, we will be obligated to make payments upon the achievement of certain milestones, comprising $20.0 million upon the initiation of the first Phase 3 clinical study, up to $180.0 million upon the achievement of regulatory and first commercial sale milestones in certain territories and up to $1.0 billion based on the achievement of certain thresholds for net sales of lebrikizumab for all indications.

Royalty payments will be made from the first commercial sale date in such country and end on the later of the date that is (i) ten years after the date of the first commercial sale of lebrikizumab in such country, (ii) the expiration of the last to expire valid claim of the applicable licensed compound patent rights, our patent rights or joint patent rights in such country covering the use, manufacturing, import, offering for sale, or sale of lebrikizumab in such country, (iii) the expiration of the last to expire valid claim of the applicable licensed non-compound patent rights in such country covering the use, import, offering for sale, or sale of the product in such country, or (iv) the expiration of the last to expire regulatory exclusivity conferred by the applicable regulatory authority in such country for lebrikizumab.

Rose U Agreement

In April 2013, we entered into an exclusive license agreement with Rose U LLC (“Rose U”) pursuant to which we obtained a worldwide exclusive license within a field of use including hyperhidrosis to practice, enforce and otherwise exploit certain patent rights, know‑how and data related to our hyperhidrosis program. The license agreement includes a sublicense of certain data and an assignment of certain regulatory filings which Rose U had obtained from Stiefel Laboratories, Inc., a GSK company (“Stiefel”). In connection with the license agreement, we also entered into a letter agreement with Stiefel pursuant to which we assumed Rose U’s obligation to pay Stiefel $2.5 million in connection with the commercialization of products developed using the licensed data and to indemnify Stiefel for claims arising from the use, development or commercialization of products developed using the Stiefel data.

As of March 31, 2019, we have paid or accrued license and other fees of $4.3 million to Rose U and Stiefel, including a $2.5 million payment in connection with the first commercial sale of QBREXZA in 2018, and are required to pay Rose U additional amounts totaling up to $0.6 million upon the achievement of certain milestones. In addition, we are also obligated to pay Rose U low-to-mid single-digit royalties on net product sales and low double-digit royalties on sublicense fees and certain milestone, royalty and other contingent payments received from sublicensees, to the extent such amounts are in excess of the milestone and royalty payments we are obligated to pay Rose U directly upon the events or sales triggering such payments. As of March 31, 2019, of the $2.5 million payment made to Rose U, we are entitled to credit the remaining $2.4 million against current and future royalty payments owed to Rose U in accordance with the terms of the license agreement.

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Out-license and Other Agreements

Almirall Agreement

We entered into an option and license agreement with Almirall, S.A. (“Almirall”) in February 2019 (“Almirall Agreement”), under which Almirall acquired an option to exclusively license rights to develop lebrikizumab for the treatment or prevention of dermatology indications, including but not limited to atopic dermatitis, and commercialize lebrikizumab for the treatment or prevention of all indications in Europe. In exchange, we received a non-refundable upfront option fee of $30.0 million in March 2019. We are obligated to provide Almirall with a data package consisting of topline and additional data, along with a development plan, after which Almirall has 45 days to exercise its option, if at all. If the option is exercised, we will receive a $50.0 million option exercise fee and will be eligible to receive additional development, regulatory and sales milestone payments, as well as low double-digit royalties for the first annual net sales tier with increases up to the low twenties for the highest net sales tier.

We evaluated the terms of the Almirall Agreement and determined that the data package, development plan and license option resulted in one combined performance obligation related to the option granted to Almirall. As of March, 31, 2019, we recorded $30.0 million of deferred revenue, current on our condensed consolidated balance sheets. The transaction price attributed to the option will not be eligible to be recognized until the option expires or is exercised.

Maruho Agreement

In September 2016, we entered into an Exclusive License Agreement with Maruho Co., Ltd. (“Maruho”), which grants Maruho an exclusive license to develop and commercialize glycopyrronium tosylate for the treatment of hyperhidrosis in Japan (“Maruho Agreement”). Pursuant to the terms of the Maruho Agreement, we received an upfront payment of $25.0 million from Maruho in October 2016 and are eligible to receive additional payments totaling up to $70.0 million, contingent upon the achievement of certain milestones associated with submission and approval of a marketing application in Japan and certain sales thresholds, as well as royalty payments based on a percentage of net product sales in Japan. The Maruho Agreement further provides that Maruho will be responsible for funding all development and commercial costs for the program in Japan and, until such time, if any, as Maruho elects to establish its own source of supply of drug product, Maruho will purchase product supply from us for development and, if applicable, commercial purposes at cost.

Under Topic 606, we evaluated the terms of the Maruho Agreement and the transfer of intellectual property rights (the “license”) was identified as the only performance obligation as of the inception of the agreement. We concluded that the license for the intellectual property was distinct from our ongoing manufacturing obligations. We further determined that the transaction price under the arrangement was comprised of the $25.0 million upfront payment. The future potential milestone amounts were not included in the transaction price, as they were all determined to be fully constrained. As part of our evaluation of the development and regulatory milestones constraint, we determined that the achievement of such milestones is contingent upon success in future clinical trials and regulatory approvals, each of which is uncertain at this time. We will re-evaluate the transaction price each quarter and as uncertain events are resolved or other changes in circumstances occur. Future potential milestone amounts would be recognized as revenue from collaboration arrangements, if unconstrained. Reimbursable program costs are recognized proportionately with the performance of the underlying services or delivery of drug substance and are accounted for as reductions to R&D expense and are excluded from the transaction price.

Unless earlier terminated, the Maruho Agreement will remain in effect until the later of: (i) expiration or abandonment of the last valid claim of the applicable patent rights in Japan; (ii) expiration of any market exclusivity in Japan granted by the applicable regulatory authority; and (iii) 15 years following the date of the first commercial sale of the drug product in Japan.

UCB Agreements

In March 2014, we and UCB Pharma S.A. (“UCB”), entered into a Development and Commercialisation Agreement, dated March 21, 2014 (“UCB Agreement”), which provided that we would (a) develop Cimzia (certolizumab pegol) for the treatment of psoriasis in order for UCB to seek regulatory approval from the U.S. Food and Drug Administration (“FDA”), the European Medicines Agency and the Canadian federal department for health, and (b) upon the grant of regulatory approval in the United States and Canada, promote sales of Cimzia to dermatologists and conduct related medical affairs activities in the United States and Canada. The UCB Agreement also provided either party with the right to terminate the agreement under certain terms. We expressed our intent to terminate the UCB Agreement in accordance with its terms.

As a result, we and UCB entered into an agreement on November 6, 2017 to effect the termination of the UCB Agreement and an orderly transition of the development and commercialization activities under the UCB Agreement from us to UCB (“Transition Agreement”). The Transition Agreement, among other things, (a) terminated the UCB Agreement on February 15, 2018, (b) provided for the repurchase by UCB of all product rights, licenses and intellectual property relating to Cimzia, (c) specified the responsibilities

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and obligations of us and UCB in connection with the transition of certain activities under the UCB Agreement from us to UCB as a result of the termination of the UCB Agreement, (dterminated UCB’s right to designate a director nominee to our board of directors and (eprovided for the resignation of UCB’s designee from our board of directors.

Pursuant to the UCB Agreement, there were no termination or penalty payments required by either party. In consideration for the repurchase of all product rights, licenses and intellectual property relating to Cimzia, UCB paid us $11.0 million in November 2017 and an additional $39.0 million in June 2018 upon FDA approval of Cimzia for the treatment of psoriasis. We were obligated to reimburse UCB for up to $10.0 million of development costs incurred by UCB in connection with the development of Cimzia between January 1, 2018 and June 30, 2018. As of December 31, 2018, we had fully reimbursed UCB the $10.0 million for development costs incurred by UCB.

 

8. Stock-Based Compensation

The following table reflects a summary of stock option activity under our 2010 Equity Incentive Plan (“2010 Plan”), 2014 Equity Incentive Plan (“2014 EIP”) and 2018 Equity Inducement Plan (“2018 Inducement Plan”) and related information for the period from December 31, 2018 through March 31, 2019:

 

 

 

Shares

Subject to

Outstanding Stock

Options

 

 

Weighted-

Average

Exercise Price

Per Share

 

Stock options outstanding at December 31, 2018

 

 

6,950

 

 

$

19.06

 

Stock options granted

 

 

931

 

 

$

7.35

 

Stock options exercised

 

 

(13

)

 

$

1.74

 

Stock options forfeited

 

 

(124

)

 

$

25.39

 

Stock options outstanding at March 31, 2019

 

 

7,744

 

 

$

17.58

 

The following table reflects a summary of restricted stock unit (“RSU”) activity under our 2014 EIP and 2018 Inducement Plan and related information for the period from December 31, 2018 through March 31, 2019:

 

 

 

Shares

Subject to

Outstanding

RSUs

 

 

Weighted-

Average

Grant Date Fair Value

Per Share

 

RSUs outstanding at December 31, 2018

 

 

1,572

 

 

$

13.50

 

RSUs granted

 

 

1,120

 

 

$

7.03

 

RSUs vested and settled

 

 

(9

)

 

$

22.03

 

RSUs forfeited

 

 

(44

)

 

$

11.55

 

RSUs outstanding at March 31, 2019

 

 

2,639

 

 

$

10.76

 

Total stock-based compensation expense related to the 2010 Plan, the 2014 EIP, the 2018 Inducement Plan and the 2014 Employee Stock Purchase Plan was allocated as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2019

 

 

2018

 

Cost of sales

 

$

15

 

 

$

 

Research and development

 

$

2,460

 

 

$

2,853

 

Selling, general and administrative

 

 

5,506

 

 

 

4,661

 

Total stock-based compensation expense

 

$

7,981

 

 

$

7,514

 

 

Stock-based compensation of $0.1 million was capitalized into inventory for the three months ended March 31, 2019. Stock-based compensation capitalized into inventory is recognized as cost of sales when the related product is sold.

 

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ITEM 2.

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

The interim financial statements included in this Quarterly Report on Form 10-Q and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2018, included as part of our Annual Report on Form 10-K for the year ended December 31, 2018, and our unaudited Condensed Consolidated Financial Statements for the three-month period ended March 31, 2019 and other disclosures (including the disclosures under “Part II — Other Information, Item 1A. Risk Factors”) included in this Quarterly Report on Form 10-Q. In addition to historical information, this discussion and analysis contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “potential,” “predict,” “project,” “estimate,” or “continue,” and similar expressions or variations. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include those set forth elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II — Other Information, Item 1A. Risk Factors below, that could cause actual results to differ materially from historical results or anticipated results. Except as may be required by law, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

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, subject to an end-of-Phase 2 meeting with the U.S. Food and Drug Administration (“FDA”). We also have early-stage research and development programs in other areas of dermatology. We are headquartered in Menlo Park, California.

Our portfolio consists of:

 

QBREXZA, a topical, once-daily anticholinergic cloth that was approved by the FDA in June 2018 for the treatment of primary axillary hyperhidrosis in adult and pediatric patients nine years of age and older. Primary axillary hyperhidrosis is a medical condition with no known cause that results in underarm sweating beyond what is needed for normal body temperature regulation. Anticholinergics are a class of pharmaceutical products that exert their effect by blocking the action of acetylcholine, a neurotransmitter that transmits signals within the nervous system that are responsible for the activation of sweat glands. QBREXZA is applied directly to the skin and is designed to block underarm sweat production by inhibiting sweat gland activation. We began shipping QBREXZA to wholesalers and a preferred dispensing partner (together, “Customers”) in September 2018, and QBREXZA became commercially available in pharmacies nationwide on October 1, 2018.

 

Lebrikizumab, a novel, injectable, humanized monoclonal antibody targeting interleukin 13 (“IL‑13”) that we are developing for the treatment of moderate-to-severe atopic dermatitis. IL‑13 is a naturally occurring cytokine that is thought to play an important role in promoting allergic inflammation and mediating its effects on bodily tissues, including in patients with atopic dermatitis. Lebrikizumab is designed to bind to IL‑13 with high affinity, specifically preventing formation of the IL‑13 receptor/interleukin 4 (“IL-4”) receptor complex and subsequent signaling. In August 2017, we entered into a license agreement (the “Roche Agreement”) with F. Hoffmann-La Roche Ltd and Genentech, Inc. (collectively, “Roche”) pursuant to which we obtained exclusive, worldwide rights to develop and commercialize lebrikizumab for atopic dermatitis and all other therapeutic indications. Based on the results of two exploratory Phase 2 clinical trials conducted by Roche in atopic dermatitis patients, we initiated a Phase 2b clinical trial in January 2018 to evaluate the safety and efficacy of lebrikizumab as a monotherapy compared with placebo and to establish the dosing regimen for a potential Phase 3 program in patients with moderate-to-severe atopic dermatitis. We completed enrollment of 280 patie