kmph20170630_10q.htm
 


 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

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

 

For the quarterly period ended September 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 No. 001-36913

 


 

KemPharm, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware

 

20-5894398

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

 

 

 

1180 Celebration Boulevard, Suite 103, Celebration, FL

 

34747

(Address of Principal Executive Offices)

 

(Zip Code)

 

(321) 939-3416

(Registrant’s Telephone Number, Including Area Code)
 
 
(Former Name, Former Address, and Former Fiscal Year if Changed Since Last Report)
 

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

 

Title of each class Trading Symbol Name of each exchange on which registered
Common KMPH Nasdaq Global 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 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 Exchange Act).     Yes       No  

 

Total shares of common stock outstanding as of November 14, 2019: 33,223,877

 



 

 

 

 

 

INDEX

 

KEMPHARM, INC.

FORM 10-Q

 

    Page
     

 

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

Condensed Balance Sheets as of September 30, 2019 (UNAUDITED) and December 31, 2018

3

 

UNAUDITED Condensed Statements of Operations for the three and Nine months ended September 30, 2019 and 2018

4

  UNAUDITED CONDENSED STATEMENTS OF STOCKHOLDERS' DEFICIT FOR THE Nine MONTHS ENDED September 30, 2019 AND 2018 5

 

Unaudited condensed Statements of Cash Flows for the Nine months ended September 30, 2019 and 2018

7

 

Notes to unaudited Condensed Financial Statements

8

Item 2.

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

36

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

52

Item 4.

Controls and Procedures

52

 

 

 

 

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

53

Item 1A.

Risk Factors

53

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

113

Item 3.

Defaults Upon Senior Securities

113

Item 4.

Mine Safety Disclosures

113

Item 5.

Other Information

113

Item 6.

Exhibits

114

 

 

 

 

Signatures

115

 

 

 

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

KEMPHARM, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share and par value amounts)

 

   

September 30,

 

December 31,

   

2019

 

2018

   

(unaudited)

       

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 6,518     $ 18,409  

Marketable securities

          3,260  
Accounts and other receivables     1,638       140  

Prepaid expenses and other current assets

    528       1,912  

Total current assets

    8,684       23,721  

Property and equipment, net

    1,541       1,753  
Operating lease right-of-use assets     1,649        
Restricted cash     490       710  

Other long-term assets

    526       562  

Total assets

  $ 12,890     $ 26,746  
                 

Liabilities and stockholders' deficit

               

Current liabilities:

               

Accounts payable and accrued expenses

  $ 3,095     $ 8,342  
Current portion of convertible notes     6,718       3,333  

Current portion of capital lease obligation

          214  
Current portion of operating lease liabilities     369        

Other current liabilities

    227       115  

Total current liabilities

    10,409       12,004  

Convertible notes, less current portion, net

    70,553       78,105  

Derivative and warrant liability

    335       2,118  
Capital lease obligation, less current portion           396  
Operating lease liabilities, less current portion     1,976        

Other long-term liabilities

    237       689  

Total liabilities

    83,510       93,312  
                 

Commitments and contingencies (Note D)

               
                 

Stockholders’ deficit:

               
Preferred stock:                
Series A convertible preferred stock, $0.0001 par value, 9,578 shares authorized, 9,577 shares issued and 3,337 shares outstanding as of September 30, 2019 (unaudited) and December 31, 2018            
Series B-1 convertible preferred stock, $0.0001 par value, 1,576 shares authorized, 1,576 shares issued and 789 shares outstanding as of September 30, 2019 (unaudited); no shares authorized, issued or outstanding as of December 31, 2018            
Series B-2 convertible preferred stock, $0.0001 par value, 27,000 shares authorized, no shares issued or outstanding as of September 30, 2019 (unaudited); no shares authorized, issued or outstanding as of December 31, 2018            
Undesignated preferred stock, $0.0001 par value, 9,961,846 shares authorized, no shares issued or outstanding as of September 30, 2019 (unaudited); 9,990,422 shares authorized, no shares issued or outstanding as of December 31, 2018            

Common stock, $0.0001 par value, 250,000,000 shares authorized, 32,387,382 shares issued and outstanding as of September 30, 2019 (unaudited); 26,455,352 shares issued and outstanding as of December 31, 2018

    3       3  

Additional paid-in capital

    169,054       154,623  

Accumulated deficit

    (239,677 )     (221,192

)

Total stockholders' deficit

    (70,620 )     (66,566

)

Total liabilities and stockholders' deficit

  $ 12,890     $ 26,746  

 

See accompanying notes to unaudited condensed financial statements

  

3

 

 

 

KEMPHARM, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

  

     Three months ended September 30,         Nine months ended September 30,  
     2019       2018    2019     2018  
Revenue   $ 11,463     $     $ 11,463     $  
Operating expenses:                                
Cost of revenue     1,000             1,000        
Research and development     3,616       13,330       16,950       35,455  
General and administrative     3,613       2,992       9,440       9,544  
Severance expense           1,636             1,636  
Total operating expenses     8,229       17,958       27,390       46,635  
Income (loss) from operations     3,234       (17,958 )     (15,927 )     (46,635 )
Other (expense) income:                                
Interest expense related to amortization of debt issuance costs and discount     (371 )     (326 )     (981 )     (1,106 )
Interest expense on principal     (1,208 )     (1,367 )     (3,669 )     (4,228 )
Fair value adjustment related to derivative and warrant liability     1,351       4,468       1,783       289  
Interest and other income, net     60       52       295       290  
Total other (expense) income     (168 )     2,827       (2,572 )     (4,755 )
Income (loss) before income taxes     3,066       (15,131 )     (18,499 )     (51,390 )
Income tax (expense) benefit     (3 )     60       14       107  
Net income (loss)   $ 3,063     $ (15,071 )   $ (18,485 )   $ (51,283 )
                                 
Net income (loss) per share of common stock:                                
Basic   $ 0.09     $ (0.94 )   $ (0.65 )   $ (3.33 )
Diluted   $ 0.06     $ (0.94 )   $ (0.65 )   $ (3.33 )
                                 
Weighted average number of shares of common stock outstanding:                                
Basic     30,126,704       16,033,923       28,417,450       15,385,663  
Diluted     31,672,149       16,033,923       28,417,450       15,385,663  

 

See accompanying notes to unaudited condensed financial statements

 

4

 

 

 

KEMPHARM, INC.

UNAUDITED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT

(in thousands)

 

   

Preferred Stock

                                 
   

Series A

   
Series B-1
   
Series B-2
                                         
   

Convertible

   
Convertible
   
Convertible
   

Undesignated

            Additional             Total  
   

Preferred

   
Preferred
   
Preferred
   

Preferred

   

Common

    Paid-in     Accumulated     Stockholders'  
   

Stock

   
Stock
   
Stock
   

Stock

   

Stock

    Capital     Deficit     Equity  

Balance as of January 1, 2019

  $     $     $     $     $ 3     $ 154,623     $ (221,192

)

  $ (66,566

)

Net loss

                                        (12,291

)

    (12,291

)

Stock-based compensation expense

                                  1,290             1,290  

Issuance of common stock in connection with Purchase Agreement

                                  2,721             2,721  

Write-off of deferred offering costs

                                  10             10  
Balance as of March 31, 2019                             3       158,644       (233,483 )     (74,836 )
Net loss                                         (9,257 )     (9,257 )
Stock-based compensation expense                                   1,317             1,317  
Issuance of common stock in connection with Purchase Agreement                                   1,229             1,229  
Balance as of June 30, 2019                             3       161,190       (242,740 )     (81,547 )
Net income                                         3,063       3,063  
Stock-based compensation expense                                   1,057             1,057  
Issuance of common stock in connection with Purchase Agreement                                   1,496             1,496  
Conversion of principal on 2021 Notes                                   3,000             3,000  
Change in fair value of embedded conversion feature in connection with debt modification                                   2,311             2,311  

Balance as of September 30, 2019

  $     $     $     $     $ 3     $ 169,054     $ (239,677

)

  $ (70,620

)

 

See accompanying notes to financial statements

 

5

 

 

KEMPHARM, INC.

UNAUDITED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT, (continued)

(in thousands)

 

   

Preferred Stock

                               
   

Series A

  Series B-1     Series B-2                                        
   

Convertible

  Convertible    Convertible   

Undesignated

       

 

Additional            

 

Total  
   

Preferred

  Preferred    Preferred   

Preferred

 

Common

    Paid-in    

 

Accumulated    

 

Stockholders'  
   

Stock

  Stock    Stock   

Stock

 

Stock

    Capital    

 

Deficit    

 

Deficit  

Balance as of January 1, 2018

  $     $     $     $     $ 1     $ 107,209     $ (164,726

)

  $ (57,516

)

Net loss

           —                               (26,219

)

    (26,219

)

Stock-based compensation expense

           —        —                   1,281             1,281  

Issuance of common stock in connection with ATM, net of commissions

           —        —             1       2,797             2,798  

Offering expenses charged to equity

           —        —                   (27 )           (27 )
Balance as of March 31, 2018            —        —             2       111,260       (190,945 )     (79,683 )
Net loss            —        —                         (9,993 )     (9,993 )
Stock-based compensation expense            —        —                   1,378             1,378  
Issuance of common stock in connection with ATM, net of commissions            —        —                   1,194             1,194  
Offering expenses charged to equity            —        —                   (11 )           (11 )
Conversion of principal and interest on Deerfield Convertible Note            —        —                   3,502             3,502  
Exercise of stock options            —        —                   68             68  
Balance as of June 30, 2018            —        —                    117,391       (200,938 )      (83,545 )
Net loss      —        —        —        —        —        —       (15,071 )      (15,071 )
Stock-based compensation expense      —        —        —        —        —        2,586        —        2,586  
Issuance of common stock in connection with ATM, net of commissions      —        —        —        —        —        836        —        836  
Offering expenses charged to equity      —        —        —        —        —        (151 )      —        (151 )

Balance as of September 30, 2018

  $     $  —     $  —     $     $ 2     $ 120,662     $ (216,009

)

  $ (95,345

)

 

See accompanying notes to financial statements

 

6

 

 

 

KEMPHARM, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

 

   

Nine months ended September 30,

   

2019

 

2018

Cash flows from operating activities:

               

Net loss

  $ (18,485 )   $ (51,283 )

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

               

Stock-based compensation expense

    3,664       5,245  

Non-cash interest expense

    988       1,123  

Amortization of debt issuance costs and debt discount

    981       1,106  

Depreciation and amortization expense

    229       245  

Fair value adjustment related to derivative and warrant liability

    (1,783 )     (289

)

Write-off of deferred offering costs     10        

Change in assets and liabilities:

               
Accounts and other receivables     (1,498 )     (86 )

Prepaid expenses and other assets

    1,420       (960 )
Operating lease right-of-use assets     (1,649 )      

Accounts payable and accrued expenses

    (6,073 )     5,780

 

Operating lease liabilities     2,345        

Other liabilities

    (788 )     (86 )

Net cash used in operating activities

    (20,639 )     (39,205

)

                 

Cash flows from investing activities:

               

Purchases of property and equipment

    (21 )     (6

)

Maturities of marketable securities

    3,260       25,374  

Net cash provided by investing activities

    3,239       25,368

 

                 

Cash flows from financing activities:

               
Proceeds from equity line of credit     5,446        

Proceeds from at-the-market offering, net of commissions

          4,828  
Repayment of obligations under capital lease           (142 )
Repayment of principal on finance lease liabilities     (157 )      
Proceeds from exercise of common stock options           68  

Net cash provided by financing activities

    5,289       4,754  

Net decrease in cash, cash equivalents and restricted cash

    (12,111 )     (9,083

)

Cash, cash equivalents and restricted cash, beginning of period

    19,119       11,971  

Cash, cash equivalents and restricted cash, end of period

   $ 7,008     $ 2,888  
                 

Supplemental cash flow information:

               

Cash paid for interest

   $ 4,602     $ 5,280  
Deferred offering costs included in accounts payable and accrued expenses     105       68  
Deerfield Convertible Note principal and interest converted to common stock           3,502  
Property and equipment financed under a lease agreement           52  
2021 Notes principal converted to common stock     1,424        
2021 Notes principal converted to Series B-1 Preferred Stock     1,576        
Change in fair value of embedded conversion feature recorded as debt discount in connection with debt modification     2,311        

 

See accompanying notes to unaudited condensed financial statements.

 

7

 

 

KEMPHARM, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

 
A. Description of Business and Basis of Presentation

 

Organization

 

KemPharm, Inc. (the “Company”) is a specialty pharmaceutical company focused on the discovery and development of proprietary prodrugs to treat serious medical conditions through its proprietary Ligand Activated Therapy ("LAT™") technology. The Company utilizes its proprietary LAT technology to generate improved prodrug versions of U.S. Food and Drug Administration (the "FDA") approved drugs as well as to generate prodrug versions of existing compounds that may have applications for new disease indications. The Company's product candidate pipeline is focused on the high need areas of attention deficit hyperactivity disorder ("ADHD") and stimulant use disorder ("SUD"). The Company's clinical product candidates for the treatment of ADHD include KP415 and KP484, and the Company's preclinical product candidate for the treatment of SUD includes KP879. The Company was formed and incorporated in Iowa in October 2006 and reorganized in Delaware in May 2014.

 

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and related notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included in the accompanying financial statements. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2019.

 

This interim information should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the Securities and Exchange Commission (“SEC”) on March 1, 2019 (the "Annual Report").

 

Going Concern

 

The unaudited condensed financial statements have been prepared on a going concern basis which assumes that the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. The Company has experienced recurring negative operating cash flows and has a stockholders' deficit and net working capital (current assets less current liabilities) deficit, and its existing cash and cash equivalents and restricted cash are not sufficient to fund the Company’s operating expenses and capital expenditure requirements for at least one year from date these unaudited condensed financial statements are issued. Various internal and external factors will affect whether and when product candidates become approved drugs and how significant the market share of those approved products will be. The length of time and cost of developing and commercializing these product and product candidates and/or failure of them at any stage of the drug approval or commercialization process will materially affect the Company’s financial condition and future operations. The Company's ability to continue as a going concern may require additional financing to fund its operations. The perception of the Company's inability to continue as a going concern may make it more difficult to obtain financing for the continuation of operations and could result in the loss of confidence by investors, suppliers and employees. Adequate additional financing may not be available to the Company on acceptable terms, or at all.

 

Management believes these conditions raise substantial doubt about the Company’s ability to continue as a going concern within the twelve months after the date these financial statements are issued. Based upon the Company's current operating plan the Company believes existing cash resources are sufficient to fund operating expense and capital investment requirements into, but not through, the second quarter of 2020. The ability to continue as a going concern is dependent upon profitable future operations, positive cash flows, the forebearance of the Company's lenders and additional financing. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

8

 

 

Management intends to finance operating costs over the next twelve months with existing cash and cash equivalents and restricted cash, as well as payments arising from our license agreements and additional financing through the Company's active registration statement on Form S-3 covering the sale of up to $150.0 million of the Company's common stock, preferred stock, and debt and/or warrants, if available (the “Current Registration Statement”). In October 2019, the Company filed a registration on Form S-3 covering the sale of up to $80.0 million of the Company's common stock, preferred stock, and debt and/or warrants (the “Replacement Registration Statement”). Once the Replacement Registration Statement is declared effective by the SEC, the Company will no longer make any sales under the Current Registration Statement.

 

After the Company filed its Annual Report, in order to issue securities under the Current Registration Statement and the Replacement Registration Statement, once effective, it must rely on Instruction I.B.6. of Form S-3, which imposes a limitation on the maximum amount of securities that the Company may sell pursuant to the registration statements during any twelve-month period. At the time it sells securities pursuant to the applicable registration statement, the amount of securities to be sold plus the amount of any securities it has sold during the prior twelve months in reliance on Instruction I.B.6. may not exceed one-third of the aggregate market value of its outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale, as computed in accordance with Instruction I.B.6. This calculation was updated immediately after the Company’s filed the Annual Report and the amount of securities the Company was then able to sell under a registration statement on Form S-3 during a 12-month period was approximately $18.5 million, of which the Company filed prospectus supplements to register (i) approximately $15.3 million for sales under the Purchase Agreement (as defined below); and (ii) approximately $3.2 million for sales under the Second ATM Agreement (as defined below). Based on this calculation, the Company expects it will be unable to sell additional securities beyond those amounts pursuant to the Current Registration Statement or the Replacement Registration Statement, once effective, for a period of twelve months, unless and until the market value of its outstanding common stock held by non-affiliates increases significantly. In addition, under the terms of the Purchase Agreement, stockholder approval may be required to access a portion of the amounts available under the Purchase Agreement. As of September 30, 2019, the Company has sold 3,401,271 shares of common stock for approximately $5.4 million in gross proceeds under the Purchase Agreement and no shares of common stock under the Second ATM Agreement.

 

Reclassifications

 

During the third quarter of 2019, the Company began presenting accounts and other receivables as a separate line item on the condensed balance sheets and condensed statements of cash flows. In prior periods, accounts and other receivables were reported within the prepaid expenses and other current assets line items in the condensed balance sheets and condensed statements of cash flows. In accordance with GAAP, the change in current period presentation requires a  reclassification of prior period balances. The reclassification of prior period balances resulted in a reduction of prepaid expenses and other current assets of $0.1 million on the Company’s condensed balance sheet for the period ended December 31, 2018 and a reduction in change in prepaid expenses and other assets of $0.1 million on the Company's condensed statement of cash flows for the nine month period ended September 30, 2018. This reclassification had no effect on the condensed statements of operations.

 

Entry into First ATM Agreement

 

In October 2016, the Company entered into a Common Stock Sales Agreement (the “First ATM Agreement”) with Cowen and Company, LLC (“Cowen”). The First ATM Agreement was terminated in September 2018. Prior to termination of the First ATM Agreement, the Company sold an aggregate of 762,338 shares of common stock under the First ATM Agreement resulting in gross proceeds to the Company of $4.9 million. The Company paid Cowen a commission of up to three percent (3.0%) of the gross sales proceeds for such sales of common stock. Pursuant to the terms of the First ATM Agreement, specified obligations of the parties, including the Company’s indemnification obligations to Cowen, survive the termination of the First ATM Agreement.

 

9

 

 

Entry into Second ATM Agreement

 

In September 2018, the Company entered into a Common Stock Sales Agreement (the “Second ATM Agreement”) with RBC Capital Markets, LLC (“RBCCM”) under which the Company may offer and sell, from time to time, in its sole discretion, shares of common stock having an aggregate offering price of up to $50,000,000 through RBCCM as its sales agent. The Company’s registration statement on Form S-3 contemplated under the Second ATM Agreement was declared effective by the SEC on October 17, 2016. The registration statement on Form S-3 includes a prospectus supplement covering the offering of up to $50,000,000 of shares of common stock in accordance with the Second ATM Agreement. In March 2019, the Company filed an updated prospectus supplement regarding the Second ATM Agreement covering the offering of up to $3.2 million of shares of common stock in order to be in compliance with Instruction I.B.6 of Form S-3. As of September 30, 2019, the Company has not sold any shares of common stock under the Second ATM Agreement.

 

RBCCM may sell common stock under the Second ATM Agreement by any method permitted by law deemed to be an “at the market offering” as defined in Rule 415 of the Securities Act of 1933, as amended (the "Securities Act"), including without limitation sales made by means of ordinary brokers’ transactions on the Nasdaq Global Market or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by the Company. RBCCM will use commercially reasonable efforts to sell the common stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company will pay RBCCM a commission of up to three percent (3.0%) of the gross sales proceeds of any common stock sold through RBCCM under the Second ATM Agreement, and also has provided RBCCM with customary indemnification rights.

 

The Company is not obligated to make any sales of common stock under the Second ATM Agreement. The offering of shares of common stock pursuant to the Second ATM Agreement will terminate upon the earlier of (i) the sale of all common stock subject to the Second ATM Agreement, or (ii) termination of the Second ATM Agreement in accordance with its terms.

 

Underwritten Public Offering

 

In October 2018, the Company entered into an underwriting agreement (the “Underwriting Agreement”) with RBCCM, pursuant to which, on October 10, 2018, the Company sold 8,333,334 shares of common stock of the Company in an underwritten public offering pursuant to the Company's registration statement on Form S-3, filed with the SEC on October 17, 2016, and a related prospectus and prospectus supplement, filed with the SEC on October 17, 2016 and October 5, 2018, respectively. The offering price to the public was $3.00 per share. The Company’s net proceeds from the offering were approximately $23.1 million, after deducting underwriting discounts and commissions and estimated offering expenses.

 

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Entry into Purchase Agreement

 

In February 2019, the Company entered into a purchase agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“Lincoln Park”) which provides that, upon the terms and subject to the conditions and limitations set forth therein, the Company may sell to Lincoln Park up to $15.0 million of shares of common stock from time to time over the 36-month term of the Purchase Agreement, and upon execution of the Purchase Agreement the Company issued an additional 120,200 shares of common stock to Lincoln Park as commitment shares in accordance with the closing conditions within the Purchase Agreement.  Concurrently with entering into the Purchase Agreement, the Company also entered into a registration rights agreement with Lincoln Park (the “Registration Rights Agreement”) pursuant to which the Company agreed to register the sale of the shares of common stock that have been and may be issued to Lincoln Park under the Purchase Agreement pursuant to the Company’s existing shelf registration statement on Form S-3 or a new registration statement. As of September 30, 2019, the Company has sold 3,401,271 shares of common stock to Lincoln Park under the Purchase Agreement for approximately $5.4 million in gross proceeds.

 

Entry into License Agreement

 

In September 2019, the Company entered into a Collaboration and License Agreement (the “KP415/484 License Agreement”) with Commave Therapeutics SA, an affiliate of Gurnet Point Capital (“Commave”). Under the KP415/484 License Agreement, the Company granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize the Company’s product candidates containing serdexmethylphenidate ("SDX") and d-methylphenidate ("d-MPH"), including KP415, KP484, and, at the option of Commave, KP879, KP922 or any other product candidate developed by the Company containing SDX and developed to treat ADHD or any other central nervous system disorder (the “Additional Product Candidates” and, collectively with KP415 and KP484, the “Licensed Product Candidates”). Pursuant to the KP415/484 License Agreement, Commave (i) paid the Company an upfront payment of $10.0 million; (ii) agreed to pay milestone payments of up to $63.0 million upon the occurrence of specified regulatory milestones related to the KP415 and KP484; (iii) agreed to pay additional payments of up to $420.0 million upon the achievement of specified U.S. sales milestones; and (iv) has agreed to pay the Company quarterly, tiered royalty payments ranging from a percentage in the high single digits to the mid-twenties of Net Sales (as defined in the KP415/484 License Agreement) in the United States and a percentage in the low to mid-single digits of Net Sales in each country outside the United States, in each case subject to specified reductions under certain conditions as described in the KP415/484 License Agreement. Commave is obligated to make such royalty payments on a product-by-product basis until expiration of the Royalty Term (as defined in the KP415/484 License Agreement) for the applicable product.

 

Commave has also agreed to be responsible and reimburse the Company for all of development, commercialization and regulatory expenses for the Licensed Product Candidates, subject to certain limitations as set forth in the Commave License Agreement.

 

The KP415/484 License Agreement also establishes a joint steering committee, which will monitor progress in the development of the KP415 and KP484. Subject to the oversight of the joint steering committee, the Company otherwise retains all responsibility for the conduct of all regulatory activities required to obtain new drug application approval of KP415 and KP484; provided that Commave shall be the sponsor of any clinical trials conducted by the Company on behalf of Commave.

 

In accordance with the terms of the Company’s March 20, 2012 Termination Agreement with Aquestive Therapeutics (formerly known as MonoSol Rx, LLC), Aquestive Therapeutics has the right to receive an amount equal to 10% of any royalty or milestone payments made to the Company related to KP415, KP484 or KP879 under the KP415/484 License Agreement.

 

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B. Summary of Significant Accounting Policies

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

On an ongoing basis, the Company evaluates its estimates and assumptions, including those related to revenue recognition, the useful lives of property and equipment, the recoverability of long-lived assets, the incremental borrowing rate for leases, and assumptions used for purposes of determining stock-based compensation, income taxes, and the fair value of the derivative and warrant liability, among others. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable, the results of which form the basis for making judgments about the carrying value of assets and liabilities.

 

Revenue Recognition

 

The Company commenced recognizing revenue in accordance with the provisions of ASC 606, Revenue from Contracts with Customers (“ASC 606”), starting January 1, 2018. However, the Company had no revenue at that time.

 

Arrangements with Multiple-Performance Obligations

 

From time to time, the Company enters into arrangements for research and development, manufacturing and/or commercialization services. Such arrangements may require the Company to deliver various rights, services, including intellectual property rights/licenses, research and development services, and/or commercialization services. The underlying terms of these arrangements generally provide for consideration to the Company in the form of nonrefundable upfront license fees, development and commercial performance milestone payments, royalty payments, and/or profit sharing.

 

In arrangements involving more than one performance obligation, each required performance obligation is evaluated to determine whether it qualifies as a distinct performance obligation based on whether (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available and (ii) the good or service is separately identifiable from other promises in the contract. The consideration under the arrangement is then allocated to each separate distinct performance obligation based on its respective relative stand-alone selling price. The estimated selling price of each deliverable reflects the Company's best estimate of what the selling price would be if the deliverable was regularly sold by the Company on a stand-alone basis or using an adjusted market assessment approach if selling price on a stand-alone basis is not available.

 

The consideration allocated to each distinct performance obligation is recognized as revenue when control of the related goods or services is transferred. Consideration associated with at-risk substantive performance milestones is recognized as revenue when it is probable that a significant reversal of the cumulative revenue recognized will not occur. Should there be royalties, the Company utilizes the sales and usage-based royalty exception in arrangements that resulted from the license of intellectual property, recognizing revenues generated from royalties or profit sharing as the underlying sales occur.

 

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Licensing Agreements

 

The Company enters into licensing agreements with licensees that fall under the scope of ASC 606.

 

The terms of the Company’s licensing agreements typically include one or more of the following: (i) upfront fees; (ii) milestone payments related to the achievement of development, regulatory, or commercial goals; and (iii) royalties on net sales of licensed products. Each of these payments may result in licensing revenues or an offset against research and development expense.

 

As part of the accounting for these agreements, the Company 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 obligations. Generally, the estimation of the stand-alone selling price may include such estimates as, independent evidence of market price, forecasted revenues or costs, development timelines, discount rates, and probability of regulatory success. The Company evaluates each performance obligation to determine if they can be satisfied at a point in time or over time, and it measures the services delivered to the licensee which are periodically reviewed based on the progress of the related program. The effect of any change made to an estimated input component and, therefore revenue or expense recognized, would be recorded as a change in estimate. In addition, variable consideration (e.g., milestone payments) must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

 

Up-front Fees: If a license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from the transaction price 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, the Company utilizes 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.

 

Milestone Payments: At the inception of each arrangement that includes milestone payments (variable consideration), the Company evaluates whether the milestones are considered probable of being reached and estimates 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 the Company’s or the licensee’s control, such as non-operational developmental and regulatory approvals, are generally not considered probable of being achieved until those approvals are received. At the end of each reporting period, the Company re-evaluates the probability of achievement of milestones that are within its or the licensee’s control, such as operational developmental milestones and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect collaboration revenues and earnings in the period of adjustment. Revisions to the Company’s estimate of the transaction price may also result in negative licensing revenues and earnings in the period of adjustment.

 

13

 

 

KP415/484 License Agreement

 

In September 2019, the Company entered into the KP415/484 License Agreement with Commave under which the Company granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize the Company's product candidates containing SDX and d-MPH, including KP415, KP484, and, at the option of Commave, KP879, KP922 and/or any other product candidate developed by the Company containing SDX and developed to treat ADHD or any other central nervous system disorder. The license granted to Commave is distinct from other performance obligations as Commave can benefit from the license either on its own or together with other resources that are readily available and the license is separately identifiable from other promises in the KP415/484 License Agreement.

  

In exchange for the exclusive, worldwide license, discussed above, Commave paid the Company a non-refundable upfront payment of $10.0 million. The Company is also entitled to additional payments from Commave of up to $63.0 million, conditioned upon the achievement of specified regulatory milestones related to KP415 and KP484. In addition, the Company is entitled to payments from Commave of up to $420.0 million in the aggregate, conditioned upon the achievement of certain U.S. sales milestones, which are dependent upon, among other things, the timing of approval for a new drug application for KP415 and its final approved label, if any. Further, Commave will pay the Company quarterly, tiered royalty payments ranging from a percentage in the high single digits to mid-twenties of Net Sales (as defined in the KP415/484 License Agreement) in the U.S. and a percentage in the low to mid-single digits of Net Sales in each country outside of the U.S., in each case subject to specified reductions under certain conditions as described in the KP415/484 License Agreement

 

Commave also agreed to be responsible for and reimburse the Company for all of development, commercialization and regulatory expenses incurred on the licensed products, subject to certain limitations as set forth in the KP415/484 License Agreement. As part of this agreement the Company is obligated to perform consulting services on behalf of Commave related to the licensed products. For these consulting services, Commave has agreed to pay the Company a set rate per hour on any consulting services performed on behalf of Commave for the benefit of the licensed products.

 

The KP415/484 License Agreement is considered to be within the scope of ASC 606, as the transaction represents a contract with a customer where the the participants function in a customer / vendor relationship and are not exposed equally to the risks and rewards of the activities contemplated under the KP415/484 License Agreement. Using the concepts of ASC 606, the Company has identified the grant of the exclusive, worldwide license and the performance of consulting services, which includes the reimbursement of out-of-pocket third-party research and development costs, as its only two performance obligations. The Company further determined that the transaction price under the agreement was $10.0 million upfront payment plus the fair value of the Development Costs (as defined in the KP415/484 License Agreement) which was allocated among the performance obligations based on their respective related stand-alone selling price.

 

The consideration allocated to the grant of the exclusive, worldwide license was $10.0 million, which reflects the standalone selling price. The Company utilized the adjusted market assessment approach to determine this standalone selling price which included analyzing prospective offers received from various entities throughout our licensing negotiation process as well as the consideration paid to other competitors in the market for a similar type transaction. The Company determined that the intellectual property licensed under the KP415/484 License Agreement represented functional intellectual property and it has significant standalone functionality and therefore should be recognized at a point in time as opposed to over time. The revenue related to the grant of the exclusive, worldwide license was recognized at the inception of the KP415/484 License Agreement.

 

14

 

 

The consideration allocated to the performance of consulting services, which includes the reimbursement of out-of-pocket third-party research and development costs, was the fair value of the Development Costs (as defined in the KP415/484 License Agreement), which reflects the standalone selling price. The Company utilized a blended approach which took into consideration the adjusted market assessment approach and the expected cost plus a margin approach to determine this standalone selling price. This blended approach utilized the adjusted market approach and expected cost plus margin approach to value the performance of consulting services which included analyzing hourly rates of vendors in the a market who perform similar services to those of the Company to develop a range and then analyzing the average cost per hour of our internal resources and applying a margin which placed the value in the median of the previously identified range. For the reimbursement of out-of-pocket third-party research and development costs the Company utilized the expected cost plus a margin approach, which included estimating the actual out-of-pocket cost the Company expects to pay to third-parties for research and development costs and applying a margin, if necessary. The Company notes determined that no margin was necessary of these out-of-pocket third-party research and development costs as these are purely pass-through costs and the margin for managing these third-party activities is included within the value of the performance of consulting services. The Company determined that the performance of consulting services, including reimbursement of out-of-pocket third-party research and development costs, is a performance obligation that is satisfied over time as the services are performed and the reimbursable costs are paid. As such, the revenue related to the performance obligation will be recognized as the consulting services are performed and the services associated with the reimbursable out-of-pocket third-party research and development costs are incurred and paid by the Company, in accordance with the practical expedient allowed under ASC 606 regarding an entity's right to consideration from a customer in an amount that corresponds directly to the value to the customer of the entity's performance completed to date.  

 

Under the KP415/484 License Agreement, Commave was granted an exclusive option to include Additional Products as Product(s) (both as defined in the KP415/484 License Agreement) under the KP415/484 License Agreement (the "Additional Product Option"). In addition to the Additional Product Option, Commave was also granted a right of first refusal ("ROFR") to acquire, license and/or commercialize any of the Additional Product Candidates should they choose not to exercise the Additional Product Option. Should Commave just to exercise the Additional Product Option on any Additional Product Candidates, Commave and the Company shall negotiate in good faith regarding the economic terms of such Additional Product. Further, should Commave exercise the ROFR on any Additional Product Candidate, the economic terms of the agreement shall be the same as those offered to the third-party. Under ASC 606 an option to acquire additional goods or services on gives rise to a performance obligation if the option provides a material right to the customer. The Company concluded that the above described Additional Product Option and ROFR do not constitute material rights to the customer as Commave would acquire the goods or services at a to be negotiated price, which the Company expects to approximate fair value and therefore Commave would not receive a material discount on these goods or services and would obtain at market rates.  

 

The Company is entitled to additional payments from Commave conditioned upon the achievement of specified regulatory milestones related to KP415 and KP484 and the achievement of certain U.S. sales milestones, which are dependent upon, among other things, the timing of approval for a new drug application for KP415 and its final approved label, if any. Further, Commave will pay the Company quarterly, tiered royalty payments ranging from a percentage in the high single digits to mid-twenties of Net Sales (as defined in the KP415/484 License Agreement) in the U.S. and a percentage in the low to mid-single digits of Net Sales in each country outside of the U.S., in each case subject to specified reductions under certain conditions as described in the KP415/484 License Agreement. The Company concluded that these regulatory milestones, sales milestones and royalty payments each contain a significant uncertainty associated with a future event. As such, these milestone and royalty payments are constrained at contract inception and are not included in the transaction price as the Company could not conclude that it is probable a significant reversal in the amount of cumulative revenue recognized will not occur surrounding these payments. At the end of each reporting period, the Company will update its assessment of whether the milestone and royalty payments are constrained by considering both the likelihood and magnitude of the potential revenue reversal. 

 

During the three and nine months ended September 30, 2019, the Company recognized revenue of $11.5 million, which is comprised of a $10.0 million non-refundable payment for an exclusive, worldwide license, $1.2 million of reimbursement of out-of-pocket third-party research and development costs and $0.3 million for the performance of consulting services. In addition, as of September 30, 2019, the Company had receivables in the amount of $0.3 million and $1.2 million related to the performance of consulting services and the reimbursement of out-of-pocket third-party research and development costs, respectively. The cost of revenue associated with revenue recognized under the agreement with Commave was $1.0 million for the three and nine months ended September 30, 2019. There was no revenue recognized, or associated receivables and cost revenue, for the three and nine months ended September 30, 2018 or as of December 31, 2018. There was no deferred revenue related to this agreement as of September 30, 2019 or December 31, 2018.

 

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Accounts and Other Receivables

 

Accounts and other receivables consists of receivables under the KP415/484 License Agreement, as well as income tax and other receivables due to the Company. Receivables under the KP415/484 License Agreement are recorded for amounts due to the Company related to reimbursable out-of-pocket third-party research and development costs and performance of consulting services. These receivables are evaluated to determine if any reserve or allowance should be established at each reporting date. As of September 30, 2019 and December 31, 2018 no reserve or allowance has been established.

 

Application of New or Revised Accounting Standards—Adopted

 

From time to time, the Financial Accounting Standards Board (the “FASB”) or other standard-setting bodies issue accounting standards that are adopted by the Company as of the specified effective date.

 

In April 2012, President Obama signed the Jump-Start Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an emerging growth company. As an emerging growth company, the Company could have elected to adopt new or revised accounting standards when they become effective for non-public companies, which typically is later than public companies must adopt the standards. The Company has irrevocably elected not to take advantage of the extended transition period afforded by the JOBS Act and, as a result, will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires lessees to recognize operating and finance lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leases. The Company leases office space and laboratory facilities under non-cancelable operating leases. In addition, the Company leases various laboratory equipment, furniture and office equipment and leasehold improvements that are accounted for as capital leases. The Company adopted the new standard effective January 1, 2019 on a modified retrospective basis and did not restate comparative periods. The Company elected the package of practical expedients permitted under the transition guidance, which allowed the Company to carryforward its historical lease classification and its assessment on whether a contract is or contains a lease for any leases that existed prior to adoption of the new standard. The Company also elected to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the condensed statements of operations on a straight-line basis over the lease term. The Company did not elect the hindsight practical expedient, which would have allowed the Company to use hindsight in determining the lease term and in assessing any impairment of right-of-use assets during the lookback period. The adoption of ASU 2016-02 resulted in the recognition of total right-of-use assets and total lease liabilities of approximately $2.6 million on the condensed balance sheets as of January 1, 2019.

 

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In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) – I. Accounting for Certain Financial Instruments with Down Round Features and II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception ("ASU 2017-11"), which addresses the complexity of accounting for certain financial instruments with down round features and addresses the difficulty of navigating Topic 480 because of the existence of extensive pending content in the ASC as a result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. This update applies to all entities that issue financial instruments that include down round features and entities that present earnings per share in accordance with Topic 260. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The adoption of ASU 2017-11 did not have a material impact on the Company's financial statements and disclosures.

 

In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 820) – Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"), which simplifies several aspects of the accounting for nonemployee share-based payment transactions resulting from expanding the scope of Topic 718, Compensation—Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees. This update applies to all entities that enter into share-based payment transactions for acquiring goods and services from nonemployees. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The amendments in this ASU expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The adoption of ASU 2018-07 did not have a material impact on the Company's financial statements and disclosures.

 

Application of New or Revised Accounting Standards—Not Yet Adopted

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"), which modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, which the FASB finalized on August 28, 2018, including the consideration of costs and benefits. This update applies to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. The Company does not expect the adoption of ASU 2018-13 to have a material impact on the Company's financial statements and disclosures.

 

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C.

Debt Obligations

 

Deerfield Facility Agreement

 

In June 2014, the Company entered into a $60 million facility agreement (the “Deerfield Facility Agreement”) with Deerfield Private Design Fund III, LP (“Deerfield”). The first payment to the Company under the terms of the Deerfield Facility Agreement consisted of a term loan of $15 million (the “Term Note”) and a senior secured loan of $10 million (the “Deerfield Convertible Note”). As of June 30, 2016, Deerfield was no longer obligated to provide the Company any additional disbursements under the Deerfield Facility Agreement. All loans issued under the Deerfield Facility Agreement originally bore interest at 9.75% per annum, and now bear interest at 6.75% per annum. Deerfield may convert any portion of the outstanding principal and any accrued but unpaid interest on the Deerfield Convertible Note into shares of the Company’s common stock at an initial conversion price of $5.85 per share (the "Deerfield Note Put Option").

  

The Company also issued to Deerfield a warrant to purchase 14,423,076 shares of Series D redeemable convertible preferred stock (“Series D Preferred”) at an exercise price of $0.78 per share, which is exercisable until June 2, 2024 (the “Deerfield Warrant”). Upon completion of the Company's initial public offering (the "IPO"), the Deerfield Warrant automatically converted into a warrant to purchase 1,923,077 shares of the Company’s common stock at an exercise price of $5.85 per share. This warrant qualifies as a participating security under ASC Topic 260, Earnings per Share, and is treated as such in the net loss per share calculation (Note I). If a Major Transaction occurs, as defined below, Deerfield may require the Company to redeem the Deerfield Warrant for a cash amount equal to the Black-Scholes value of the portion of the Deerfield Warrant to be redeemed (the “Warrant Put Option”). A Major Transaction is (i) a consolidation, merger, exchange of shares, recapitalization, reorganization, business combination or other similar event; (ii) the sale or transfer in one transaction or a series of related transactions of all or substantially all of the assets of the Company; (iii) a third-party purchase, tender or exchange offer made to the holders of outstanding shares, such that following such purchase, tender or exchange offer a change of control has occurred; (iv) the liquidation, bankruptcy, insolvency, dissolution or winding-up affecting the Company; (v) the shares of the Company’s common stock cease to be listed on any eligible market; and (vi) at any time, the shares of the Company’s common stock cease to be registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

In addition, the Company issued to Deerfield 1,923,077 shares of Series D Preferred as consideration for the loans provided to the Company under the Deerfield Facility Agreement. Upon completion of the IPO, these shares automatically reclassified into 256,410 shares of the Company’s common stock. The Company recorded the fair value of the shares of Series D Preferred of $1.5 million, to debt issuance costs on the date of issuance. The Company recorded the fair value of the Deerfield Warrant and the embedded Warrant Put Option to debt discount on the date of issuance. The debt issuance costs and debt discount are amortized over the term of the related debt and the expense is recorded as interest expense related to amortization of debt issuance costs and discount in the condensed statements of operations.

 

Pursuant to the Deerfield Facility Agreement, the Company may not enter into specified transactions, including a debt financing in the aggregate value of $750,000 or more, other than permitted indebtedness under the Deerfield Facility Agreement, a merger, an asset sale or any other change of control transaction or any joint venture, partnership or other profit sharing arrangement, without the prior approval of Deerfield. Additionally, if the Company were to enter into a major transaction, including a merger, consolidation, sale of substantially all of its assets or other change of control transaction, Deerfield would have the ability to demand that prior to consummation of such transaction the Company repay all outstanding principal and accrued interest of any notes issued under the Deerfield Facility Agreement. Under each warrant issued pursuant to the Deerfield Facility Agreement, Deerfield has the right to demand that the Company redeem the warrant for a cash amount equal to the Black-Scholes value of a portion of the warrant upon the occurrence of specified events, including a merger, an asset sale or any other change of control transaction.

 

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The Company originally had to repay one-third of the outstanding principal amount of all debt issued under the Deerfield Facility Agreement on the fourth and fifth anniversaries of the Deerfield Facility Agreement. On September 3, 2019, the Company entered into an exchange agreement and amendment to facility agreement (discussed below) with Deerfield and Deerfield Special Situations Fund, L.P., which amended the Deerfield Facility Agreement, in order to (i) reduce the interest rate applicable under the Deerfield Facility Agreement from 9.75% to 6.75%, (ii) provide for “payment in kind” of interest on the Loans (as defined in the Deerfield Facility Agreement), and (iii) defer the Loan payments due pursuant to the Deerfield Facility Agreement until June 1, 2020. The Company is also obligated to repay $3,333,333 of principal, as well as interest capitalized from the date of the amendment through the payment date of February 14, 2020. The Company prepaid all outstanding interest and principal on the Term Note in February 2016. The outstanding principal amount due on the fourth anniversary of the Deerfield Facility Agreement and the related accrued but unpaid interest as of such date was converted in common stock of the Company in accordance with the provisions of the Deerfield Convertible Note, as amended. Refer to the section entitled Facility Agreement Waiver and Fifth Amendment to Senior Secured Convertible Note below. 

 

Interest accrued on outstanding debt under the Deerfield Facility Agreement is due quarterly in arrears. Upon notice to Deerfield, the Company had the option to have one or more of the first eight of such scheduled interest payments added to the outstanding principal amount of the debt issued under the Deerfield Facility Agreement, provided that all such interest was due on July 1, 2016. The Company elected this option on all eight of the scheduled interest payments through June 30, 2016. The accrued interest added to outstanding principal, was paid to Deerfield on July 1, 2016.

 

First Amendment to Facility Agreement, Senior Secured Convertible Note and Warrant

 

In connection with the IPO, in March 2015, the Company entered into a First Amendment (the “First Amendment) to the Deerfield Facility Agreement, the Deerfield Convertible Note and Deerfield Warrant, by and between the Company and Deerfield. The First Amendment, among other things, clarified that all references to the conversion of shares of Series D Preferred into the Company’s common stock in the Deerfield Facility Agreement, the Deerfield Convertible Note and Deerfield Warrant shall include any reclassification of the outstanding shares of Series D Preferred into shares of the Company’s common stock.

 

Second Amendment to Senior Secured Convertible Note and Warrant

 

In January 2016, the Company entered into a Second Amendment (the “Second Amendment”) to the Deerfield Convertible Note and Deerfield Warrant, by and between the Company and Deerfield. The Second Amendment, among other things, clarified the calculation of an anti-dilution adjustment of the conversion price and exercise price of the Deerfield Convertible Note and Deerfield Warrant, respectively, in the event that the Company effects a firm commitment underwritten public offering of its securities.

 

Issuance of 5.50% Senior Convertible Notes and Third Amendment to Facility Agreement, Senior Secured Convertible Note and Warrant

 

In February 2016, the Company issued $86.3 million aggregate principal amount of its 5.50% Senior Convertible Notes due 2021 (the “2021 Notes”) to Cowen and RBC Capital Markets, LLC, as representatives of the several initial purchasers (the “Initial Purchasers”), who subsequently resold the 2021 Notes to qualified institutional buyers (the “Note Offering”) in reliance on the exemption from registration provided by Rule 144A under the Securities Act.

 

The net proceeds from the Note Offering were approximately $82.8 million, after deducting the Initial Purchasers’ discount and estimated offering expenses. Concurrent with the Note Offering, the Company used approximately $18.6 million of the net proceeds from the Note Offering to repay in full the Term Note, plus all accrued but unpaid interest, a make-whole interest payment and a prepayment premium on the Term Note.

 

The 2021 Notes were issued pursuant to an Indenture, dated as of February 9, 2016 (the “Indenture”), between the Company and U.S. Bank National Association, as trustee (the "Trustee"). Interest on the 2021 Notes is payable semi-annually in cash in arrears on February 1 and August 1 of each year, beginning on August 1, 2016, at a rate of 5.50% per year. The 2021 Notes mature on February 1, 2021 unless earlier converted or repurchased. The 2021 Notes are not redeemable prior to the maturity date, and no sinking fund is provided for the 2021 Notes.

 

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The 2021 Notes are convertible at an initial conversion rate of 58.4454 shares of the Company’s common stock per $1,000 principal amount of the 2021 Notes, subject to adjustment under the Indenture, which is equal to an initial conversion price of approximately $17.11 per share of common stock. Upon conversion, the 2021 Notes will be settled in shares of the Company’s common stock, together with a cash payment in lieu of delivering any fractional share. The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, following certain corporate events that occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its 2021 Notes in connection with such a corporate event in certain circumstances.

 

If the Company undergoes a “fundamental change” (as defined in the Indenture), holders may require that the Company repurchase for cash all or any portion of their 2021 Notes at a fundamental change repurchase price equal to 100% of the principal amount of the 2021 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, holders who convert their 2021 Notes on or after the date that is one year after the last date of original issuance of the 2021 Notes may also be entitled to receive, under certain circumstances, an interest make-whole payment payable in shares of the Company’s common stock. The Company is bifurcating the fundamental change and make-whole interest payment provisions as embedded derivatives and marking them to fair value each reporting period (Note H).

 

The Indenture includes customary terms and covenants, including certain events of default after which the 2021 Notes may be due and payable immediately.

 

In connection with the Note Offering, in February 2016, the Company entered into a Third Amendment (the “Third Amendment”) to the Deerfield Facility Agreement, Deerfield Convertible Note and Deerfield Warrant with Deerfield. The Third Amendment, among other things, eliminated the Company’s ability to require Deerfield to convert the Deerfield Convertible Note into Company common stock.  In addition, pursuant to the Third Amendment, Deerfield consented to the prepayment of the Term Note and the issuance of the 2021 Notes.

 

Refer to the sections entitled Exchange Agreement and Exchange Agreement and Fifth Amendment to Facility Agreement below for a further discussion of the exchange of a portion of the 2021 Notes for shares of Series A Convertible Preferred Stock, par value $0.0001 per share (the "Series A Preferred Stock") and Series B-1 Convertible Preferred Stock, par value $0.0001 per share (the "Series B-1 Preferred Stock").

 

Fourth Amendment to Senior Secured Convertible Note and Warrant

 

In connection with entering into the First ATM Agreement, in October 2016, the Company entered into a Fourth Amendment (the “Fourth Amendment”) to the Deerfield Convertible Note and the Deerfield Warrant with Deerfield. The Fourth Amendment, among other things, clarifies the calculation of an anti-dilution adjustment of the conversion price and exercise price of the Deerfield Convertible Note and Deerfield Warrant, respectively, in the event that the Company effects an “at the market offering” as defined in Rule 415 of the Securities Act of its common stock.

 

Facility Agreement Waiver and Fifth Amendment to Senior Secured Convertible Note

 

In June 2018, the Company entered into the Facility Agreement Waiver and Fifth Amendment (the "Fifth Amendment") to the Deerfield Convertible Note with Deerfield. The Fifth Amendment, among other things, provided that (i) $3,333,333 of the principal amount, plus $168,288 of accrued interest, of the Deerfield Convertible Note issued pursuant to the terms of the Deerfield Facility Agreement was converted into 598,568 shares of the Company’s common stock, with such principal conversion amount being applied against and in full satisfaction of the amortization payment due June 2, 2018; (ii) Deerfield waived specified rights under the Deerfield Facility Agreement with regards to such principal and interest amount; and (iii) amended specified provisions of the Deerfield Convertible Note as they relate to the delivery of shares of the Company’s common stock in connection with any conversion of the Deerfield Convertible Note.

 

20

 

 

Exchange Agreement

 

In October 2018, the Company entered into an Exchange Agreement (the “October 2018 Exchange Agreement”) with Deerfield and Deerfield Special Situations Fund, L.P. (the “Holders”). Under the October 2018 Exchange Agreement, the Holders exchanged an aggregate of $9,577,000 principal amount of the 2021 Notes for an aggregate of 9,577 shares of Series A Preferred Stock. The Company also agreed to pay the Holders an amount of $95,105 in cash, which represented the amount of accrued and unpaid interest on the exchanged notes. The October 2018 Exchange Agreement contains customary representations, warranties and covenants made by the Company and the Holders. The October 2018 Exchange Agreement required the Company to reimburse the Holders for up to $25,000 of expenses relating to the exchange.

 

As a condition to closing of the October 2018 Exchange Agreement, the Company filed a Certificate of Designation of Preferences, Rights and Limitations of Series A Convertible Preferred Stock (the “Series A Certificate of Designation”) with the Secretary of State of the State Delaware, setting forth the preferences, rights and limitations of the Series A Preferred Stock.

 

Each share of Series A Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a price equal to $3.00 per share (subject to adjustment to reflect stock splits and similar events). Immediately following the exchange under the October 2018 Exchange Agreement, there were an aggregate of 3,192,334 shares of common stock issuable upon conversion of the then outstanding Series A Preferred Stock (without giving effect to the limitation on conversion described below), and, as of September 30, 2019, there were an aggregate of 1,112,334 shares of common stock issuable upon conversion of the then outstanding Series A Preferred Stock (without giving effect to the limitation on conversion described below). The Series A Preferred Stock is convertible at any time at the option of the Holders, provided that the Holders are prohibited from converting shares of Series A Preferred Stock into shares of common stock if, as a result of such conversion, such Holders (together with certain affiliates and “group” members) would beneficially own more than 4.985% of the total number of shares of the Company’s common stock then issued and outstanding. The Series A Preferred Stock is not redeemable. In the event of the Company’s liquidation, dissolution or winding up, the Holders will receive an amount equal to $0.0001 per share of Series A Preferred Stock, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of the Company’s assets with holders of common stock on an as-converted basis. With respect to rights upon liquidation, the Series A Preferred Stock ranks senior to the common stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving the Company’s organizational documents that materially and adversely affect the holders of Series A Preferred Stock), the Series A Preferred Stock does not have voting rights. The Series A Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that holders of Series A Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series A Certificate of Designation also provides for partial liquidated damages in the event that the Company fails to timely convert shares of Series A Preferred Stock into common stock in accordance with the Series A Certificate of Designation.

 

First Supplemental Indenture, Sixth Amendment to Deerfield Convertible Note and Fifth Amendment to Deerfield Warrant

 

In November 2018, the Company entered into a First Supplemental Indenture (the “Supplemental Indenture”) with the Trustee. Pursuant to the Supplemental Indenture, the Indenture was amended to allow each Holder (as defined in the Indenture) or any beneficial holder of any 2021 Notes to, at its option, elect a limit on beneficial ownership as to such Holder or beneficial owner (but not as to any other Holder or beneficial owner) that is less than or equal to the 9.985% Cap (as defined in the Indenture) or any other limit previously elected and then applicable to such Holder or beneficial owner upon written notice delivered to the Company at least three (3) business days prior to the date of effectiveness of such beneficial ownership limit (or such shorter period as may be agreed upon by the Company), specifying the percentage of shares of the Company’s common stock outstanding for the beneficial ownership limit that shall apply to such Holder or beneficial owner.

 

21

 

 

Also in November 2018, in connection with entering into the Supplemental Indenture, the Company entered into an amendment (the “Sixth Amendment”) with Deerfield to the Deerfield Convertible Note and Deerfield Warrant. The Sixth Amendment, among other things, lowers the beneficial ownership limit under both the Deerfield Convertible Note and Deerfield Warrant to 4.985% of the Company’s outstanding common stock. The Sixth Amendment also includes a notice from Deerfield that it has elected to lower the beneficial ownership limit under the 2021 Notes, as to Deerfield and its affiliates, to 4.985%.

 

Seventh Amendment to Deerfield Convertible Note and Sixth Amendment to Deerfield Warrant

 

In February 2019, in connection with entering into the Purchase Agreement, the Company entered into an amendment (the “Seventh Amendment”), with Deerfield to the Deerfield Convertible Note and Deerfield Warrant. The Seventh Amendment, among other things, clarified that the anti-dilution protections contained in the Deerfield Convertible Note and Deerfield Warrant would not apply to sales made under the Purchase Agreement or Second ATM Agreement. The Seventh Amendment also included a waiver from Deerfield regarding any registration rights it may have under the Company’s amended and restated investor rights agreement in connection with the Registration Rights Agreement.

 

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Exchange Agreement and Fifth Amendment to Facility Agreement

 

On September 3, 2019, the Company entered into an Exchange Agreement and Amendment to Facility Agreement (the “September 2019 Exchange Agreement”) with the Holders. Under the September 2019 Exchange Agreement, the Company issued an aggregate of 1,499,894 shares of the Company’s common stock and an aggregate of 1,576 shares of the Company’s Series B-1 Convertible Preferred Stock (such shares of common stock and Series B-1 Preferred Stock, the “Initial Exchange Shares”), in exchange for the cancellation of an aggregate of $3,000,000 principal amount of the Company’s 2021 Notes. The September 2019 Exchange Agreement provides the Holders the option to exchange up to an additional aggregate of $27,000,000 principal amount of the 2021 Notes (the “Optional Exchange Principal Amount”) for shares of common stock or shares of the Company’s Series B-2 Convertible Preferred Stock, par value $0.0001 per share (the “Series B-2 Preferred Stock” and, together with the Series B-1 Preferred Stock, the “Series B Preferred Stock”), subject to the terms and conditions set forth in the September 2019 Exchange Agreement, including limits as to the principal amount that can be exchanged prior to specified dates therein. If the Holders choose to exchange any portion of the Optional Exchange Principal Amount for shares of Series B-2 Preferred Stock, such exchange will be effected at an exchange price of $1,000 per share. If the Holders choose to exchange any portion of the Optional Exchange Principal Amount for shares of common stock, such exchange will be effected at an exchange price equal to the greater of (i) $0.9494, which represents the last sale price of the common stock on the Nasdaq Global Market on September 3, 2019, or (ii) the average of the volume-weighted average price of the common stock on the Nasdaq Global Market on each of the 15 trading days immediately preceding such exchange.

 

The September 2019 Exchange Agreement also amended the Deerfield Facility Agreement, in order to (i) reduce the interest rate applicable under the Deerfield Facility Agreement from 9.75% to 6.75%, (ii) provide for “payment in kind” of interest on the Loans (as defined in the Deerfield Facility Agreement), and (iii) defer the Loan payments pursuant to the Deerfield Facility Agreement until June 1, 2020. The September 2019 Exchange Agreement contains customary representations, warranties and covenants made by the Company and the Holders. The September 2019 Exchange Agreement also requires the Company to reimburse the Holders for up to $150,000 of expenses relating to the transactions contemplated by the September 2019 Exchange Agreement.

 

The Company determined the changes to the Deerfield Facility Agreement met the definition of a troubled debt restructuring under ASC 470-60, Troubled Debt Restructurings by Debtors, as the Company was experiencing financial difficulties and Deerfield granted a concession. The amendments to the terms of the Deerfield Facility Agreement resulted in no gain on restructuring because the total cash outflows required under the amended Deerfield Facility Agreement exceeded the carrying value of the original Deerfield Facility Agreement immediately prior to amendment. Prospectively, the Deerfield Facility Agreement, and the associated Deerfield Convertible Note will continue to be carried net of the associated discount and debt issuance costs which will be amortized and recorded as interest expense using a modified effective interest rate based on the amendments.

 

The changes to the 2021 Notes, under the September 2019 Exchange Agreement, were accounted for as a debt modification with the $2.3 million change in fair value of the embedded conversion feature, associated with the Optional Exchange Principal Amount, recorded as an increase to additional paid in capital and as a debt discount to be amortized to interest expense under the effective interest method over the remaining term of the 2021 Notes.

 

As a condition to closing of the September 2019 Exchange Agreement, the Company filed a Certificate of Designation of Preferences, Rights and Limitations of Series B-1 Convertible Preferred Stock (the “Series B-1 Certificate of Designation”) and a Certificate of Designation of Preferences, Rights and Limitations of Series B-2 Convertible Preferred Stock (the “Series B-2 Certificate of Designation”) with the Secretary of State of the State Delaware, setting forth the preferences, rights and limitations of the Series B-1 Preferred Stock and the Series B-2 Preferred Stock, respectively.

 

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Each share of Series B-1 Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a per share price equal to $0.9494 per share (subject to adjustment to reflect stock splits and similar events). Immediately following the exchange under the September 2019 Exchange Agreement, there were an aggregate of 1,659,996 shares of common stock issuable upon conversion of the then outstanding Series B-1 Preferred Stock (without giving effect to the limitation on conversion described below), and, as of September 30, 2019, there was an aggregate of 831,051 shares of common stock issuable upon conversion of the then outstanding Series B-1 Preferred Stock (without giving effect to the limitation on conversion described below). Each share of Series B-2 Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a per share price equal to the greater of (i) $0.9494 (subject to adjustment to reflect stock splits and similar events), or (ii) the average of the volume-weighted average prices of the common stock on the Nasdaq Global Market on each of the 15 trading days immediately preceding such exchange. Immediately following the exchange under the September 2019 Exchange Agreement and as of September 30, 2019, there was an aggregate of 28,439,015 shares of Common Stock issuable (i) in exchange of the Optional Exchange Principal Amount, or (ii) upon conversion of the Series B-2 Preferred Stock issuable in exchange of the Optional Exchange Principal Amount (in each case without giving effect to the limitation on conversion described below).

 

The Series B Preferred Stock is convertible at any time at the option of the Holders; provided that the Holders are prohibited from converting shares of Series B Preferred Stock into shares of common stock if, as a result of such conversion, such Holders (together with certain affiliates and “group” members of such Holders) would beneficially own more than 4.985% of the total number of shares of common stock then issued and outstanding. The Series B Preferred Stock is not redeemable. In the event of the Company’s liquidation, dissolution or winding up, the Holders will receive an amount equal to $0.0001 per share, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of the Company’s assets with holders of common stock and with the holders of any shares of any other class or series of capital stock of the Company entitled to share in such remaining assets of the Company (including the Series A Preferred Stock on an as-converted basis). With respect to rights upon liquidation, the Series B Preferred Stock ranks senior to the common stock, on parity with the Series A Preferred Stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving the Company’s organizational documents that materially and adversely affect the holders of Series B Preferred Stock), the Series B Preferred Stock does not have voting rights. The Series B Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that holders of Series B Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series B-1 Certificate of Designation and the Series B-2 Certificate of Designation also provide for partial liquidated damages in the event that the Company fails to timely convert shares of Series B-1 Preferred Stock or Series B-2 Preferred Stock, respectively, into common stock in accordance with the applicable certificate of designation.

 

Except as modified by the First Amendment, Second Amendment, Third Amendment, Fourth Amendment, Fifth Amendment, Sixth Amendment, Seventh Amendment and the September 2019 Exchange Agreement, all terms and conditions of the Deerfield Facility Agreement, Deerfield Warrant and Deerfield Convertible Note remained in full force and effect.

 

Line of Credit

 

During the second quarter of 2016, the Company opened a line of credit with a total borrowing capacity of $1.1 million with City National Bank of Florida (the "Line of Credit Agreement") to support several irrevocable letters of credit issued by the bank on behalf of the Company. The line of credit had an original maturity date of January 31, 2018. On January 31, 2018, the line of credit was renewed for an additional two-year term and was set to mature on January 31, 2020. The Line of Credit Agreement was collateralized by a restricted money market account, equal to the total amount of the letters of credit outstanding which are supported by the line of credit. In March 2019, the line of credit was closed. The irrevocable letters of credit and associated money market account remain and the money market account is reported as restricted cash on the condensed balance sheets.

  

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D. Commitments and Contingencies

 

From time to time, the Company is involved in various legal proceedings arising in the normal course of business. For some matters, a liability is not probable, or the amount cannot be reasonably estimated and, therefore, an accrual has not been made. However, for such matters when it is probable that the Company has incurred a liability and can reasonably estimate the amount, the Company accrues and discloses such estimates. As of September 30, 2019 and December 31, 2018, no accruals have been made related to commitments and contingencies.

 

 
E. Preferred Stock and Warrants

 

Authorized, Issued, and Outstanding Preferred Stock

 

As of September 30, 2019, the Company had 10,000,000 shares of authorized preferred stock, of which 9,578 shares were designated as Series A Preferred Stock, 1,576 shares were designated as Series B-1 Preferred Stock and 27,000 shares were designated as Series B-2 Preferred Stock. Of the designated preferred stock 3,337 shares of Series A Preferred Stock and 789 shares of Series B Preferred Stock were issued and outstanding as of September 30, 2019. As of December 31, 2018, 3,337 shares of Series A Preferred Stock were issued and outstanding and no shares of Series B-1 Preferred stock were issued or outstanding. No shares of Series B-2 Preferred Stock were issued or outstanding as of September 30, 2019 or December 31, 2018.

 

In October 2018, the Company entered into the October 2018 Exchange Agreement. Under the October 2018 Exchange Agreement the Company issued to the Holders 9,577 shares of Series A Preferred Stock. Each share of Series A Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a price equal to $3.00 per share (subject to adjustment to reflect stock splits and similar events). Immediately following the exchange under the October 2018 Exchange Agreement, there were an aggregate of 3,192,334 shares of common stock issuable upon conversion of the Series A Preferred Stock (without giving effect to the limitation on conversion described below). The Series A Preferred Stock is convertible at any time at the option of the Holders, provided that the Holders are prohibited from converting shares of Series A Preferred Stock into shares of common stock if, as a result of such conversion, such Holders (together with certain affiliates and “group” members) would beneficially own more than 4.985% of the total number of shares of the Company's common stock then issued and outstanding. The Series A Preferred Stock is not redeemable. In the event of the Company’s liquidation, dissolution or winding up, the Holders will receive an amount equal to $0.0001 per share of Series A Preferred Stock, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of the Company’s assets with holders of common stock on an as-converted basis. With respect to rights upon liquidation, the Series A Preferred Stock ranks senior to the common stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving the Company’s organizational documents that materially and adversely affect the holders of Series A Preferred Stock), the Series A Preferred Stock does not have voting rights. The Series A Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that the holders of Series A Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series A Certificate of Designation also provides for partial liquidated damages in the event that the Company fails to timely convert shares of Series A Preferred Stock into common stock in accordance with the Series A Certificate of Designation. As of September 30, 2019, 6,240 shares of Series A Preferred Stock have been converted into 2,080,000 shares of common stock.

 

As of September 30, 2019, the Company has 3,337 shares of Series A Preferred Stock outstanding, which are convertible into 1,112,334 shares of common stock. Refer to Note C for a further discussion of the October 2018 Exchange Agreement.

 

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In September 2019, the Company entered into the September 2019 Exchange Agreement. Under the September 2019 Exchange Agreement the Company issued to the Holders 1,576 shares of Series B-1 Preferred Stock. Each share of Series B-1 Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a price equal to the greater of (i) $0.9494, which represents the last sale price of the common stock on the Nasdaq Global Market on September 3, 2019, or (ii) the average of the volume-weighted average price of the Common Stock on the Nasdaq Global Market on each of the 15 trading days immediately preceding such exchange (subject to adjustment to reflect stock splits and similar events). Immediately following the exchange under the September 2019 Exchange Agreement, there were an aggregate of 1,659,996 shares of common stock issuable upon conversion of the Series B-1 Preferred Stock (without giving effect to the limitation on conversion described below). The Series B Preferred Stock is convertible at any time at the option of the Holders; provided that the Holders are prohibited from converting shares of Series B Preferred Stock into shares of common stock if, as a result of such conversion, such Holders (together with certain affiliates and “group” members of such Holders) would beneficially own more than 4.985% of the total number of shares of common stock then issued and outstanding. The Series B Preferred Stock is not redeemable. In the event of the Company’s liquidation, dissolution or winding up, the Holders will receive an amount equal to $0.0001 per share, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of the Company’s assets with holders of common stock and with the holders of any shares of any other class or series of capital stock of the Company entitled to share in such remaining assets of the Company (including Series A Preferred Stock on an as-converted basis. With respect to rights upon liquidation, the Series B Preferred Stock ranks senior to the common stock, on parity with the Series A Preferred Stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving the Company’s organizational documents that materially and adversely affect the holders of Series B Preferred Stock), the Series B Preferred Stock does not have voting rights. The Series B Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that holders of Series B Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series B-1 Certificate of Designation and the Series B-2 Certificate of Designation also provide for partial liquidated damages in the event that the Company fails to timely convert shares of Series B-1 Preferred Stock or Series B-2 Preferred Stock, respectively, into Common Stock in accordance with the applicable Certificate of Designation. As of September 30, 2019, 787 shares of Series B-1 Preferred Stock have been converted into 828,945 shares of common stock.

As of September 30, 2019, the Company has 789 shares of Series B-1 Preferred Stock outstanding, which are convertible into 831,051 shares of common stock, and no shares of Series B-2 Preferred Stock outstanding. Refer to Note C for a further discussion of the September 2019 Exchange Agreement.

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F. Common Stock and Warrants

 

Authorized, Issued, and Outstanding Common Shares

 

As of September 30, 2019 and December 31, 2018, the Company had authorized shares of common stock of 250,000,000 shares. Of the authorized shares, 32,387,382 and 26,455,352 shares of common stock were issued and outstanding as of September 30, 2019 and December 31, 2018, respectively.

 

As of September 30, 2019 and December 31, 2018, the Company had reserved authorized shares of common stock for future issuance as follows:

 

 

   

September 30,

2019

 

December 31,

2018

Conversion of Deerfield Convertible Note

    1,192,918       1,167,607  

Conversion of 2021 Notes not subject to the Optional Exchange Principal Amount

    2,727,820       4,481,182  

Outstanding awards under equity incentive plans

    4,620,891       3,704,755  

Outstanding common stock warrants

    2,423,077       2,527,763  
Conversion of Series A Preferred Stock     1,112,334       1,112,334  
Conversion of Series B-1 Preferred Stock     831,051        
In exchange for the Optional Exchange Principal Amount*     28,439,015          

Possible future issuances under equity incentive plans

    675,966       648,272  

Total common shares reserved for future issuance

    42,023,072       13,641,913  

 

* Represents the aggregate number of shares of Common Stock issuable (i) in exchange of the Optional Exchange Principal Amount, or (ii) upon conversion of the Series B-2 Preferred Stock issuable in exchange of the Optional Exchange Principal Amount.

 

Common Stock Activity

 

The following table summarizes common stock activity for the nine months ended September 30, 2019:

 

   

Shares of

Common Stock

Balance as of December 31, 2018

    26,455,352  

Common stock issued under Purchase Agreement

    1,521,471  
Balance as of March 31, 2019     27,976,823  
Common stock issued under Purchase Agreement     800,000  
Restricted stock awards vested during the period     81,720  
Balance as of June 30, 2019     28,858,543  
Common stock issued under Purchase Agreement     1,200,000  
Common stock issued as a result of 2021 Notes principal conversion     1,499,894  
Common stock issued as a result of Series B-1 Preferred Stock conversion     828,945  

Balance as of September 30, 2019

    32,387,382  

 

In September 2018, the Company terminated the First ATM Agreement with Cowen. Prior to termination of the First ATM Agreement, the Company sold an aggregate of 762,338 shares of common stock under the First ATM Agreement resulting in gross proceeds to the Company of $4.9 million. As of September 30, 2019, the Company has not sold any shares of common stock under the Second ATM Agreement. Refer to Note A for a further discussion of the First and Second ATM Agreements.

 

In October 2018, the Company entered into an underwriting agreement with RBCCM pursuant to which the Company issued and sold 8,333,334 shares of common stock of the Company in an underwritten public offering pursuant to the Company's registration statement on Form S-3. Refer to Note A for a further discussion of the underwritten public offering.

 

Also in October 2018, the Company entered into the October 2018 Exchange Agreement pursuant to which the Company issued to the Holders 9,577 shares of Series A Preferred Stock. As of September 30, 2019, 6,240 shares of Series A Preferred Stock have been converted into 2,080,000 shares of common stock. Refer to Note C for a further discussion of the October 2018 Exchange Agreement.

 

On September 3, 2019, the Company entered into the September 2019 Exchange Agreement pursuant to which the Company issued to the Holders 1,499,894 shares of common stock and 1,576 shares of Series B-1 Preferred Stock. As of September 30, 2019, 787 shares of Series B-1 Preferred Stock have been converted into 828,945 shares of common stock. Refer to Note C for a further discussion of the September 2019 Exchange Agreement.

 

27

 

 

Warrants

 

During 2013, the Company issued $3.8 million of convertible notes and the warrants (the “2013 Warrants”) to purchase 1,079,453 shares of equity securities in a future financing meeting specified requirements (a “Qualified Financing”). The 2013 Warrants allow the holders to purchase shares of the same class and series of equity securities issued in the Qualified Financing for an exercise price equal to the per share price paid by the purchasers of such equity securities in the Qualified Financing. When the Company entered into the Deerfield Facility Agreement, the 2013 Warrants became warrants to purchase 1,079,453 shares of Series D Preferred. Upon completion of the IPO, the 2013 Warrants automatically converted into warrants to purchase 143,466 shares of the Company’s common stock at an exercise price of $5.85 per share. The 2013 Warrants expired on June 2, 2019.

 

On June 2, 2014, pursuant to the terms of the Deerfield Facility Agreement, the Company issued the Deerfield Warrant to purchase 14,423,076 shares of Series D Preferred (Note C). The Company recorded the fair value of the Deerfield Warrant as a debt discount and a warrant liability. The Deerfield Warrant, if unexercised, expires on the earlier of June 2, 2024, or upon a liquidation event. Upon completion of the IPO, the Deerfield Warrant automatically converted into a warrant to purchase 1,923,077 shares of the Company’s common stock at an exercise price of $5.85 per share. The Company is amortizing the debt discount over the term of the Deerfield Convertible Note and the expense is recorded as interest expense related to amortization of debt issuance costs and discount in the condensed statements of operations.

 

The Company determined that the 2013 Warrants and Deerfield Warrant should be recorded as a liability and stated at fair value at each reporting period upon inception. As stated above, upon completion of the IPO, the 2013 Warrants and the Deerfield Warrant automatically converted into warrants to purchase the Company’s common stock. The Company marked the 2013 Warrants to fair value and reclassified them to equity upon closing of the IPO. The Deerfield Warrant remains classified as a liability and is recorded at fair value at each reporting period since it can be settled in cash. Changes to the fair value of the warrant liability are recorded through the condensed statements of operations as a fair value adjustment (Note H).

 

In connection with a Collaboration and License Agreement (the “APADAZ License Agreement”) with KVK Tech, Inc. (“KVK”), in October 2018, the Company issued to KVK a warrant to purchase up to 500,000 shares of common stock of the Company at an exercise price of $2.30 per share, which reflected the closing price of the Company’s common stock on the Nasdaq Global Market on execution date of the APADAZ License Agreement (the “KVK Warrant”). The KVK Warrant is initially not exercisable for any shares of common stock. Upon the achievement of each of four specified milestones under the KVK Warrant, the KVK Warrant will become exercisable for an additional 125,000 shares, up to an aggregate of 500,000 shares of the Company’s common stock. The exercise price and the number and type of shares underlying the KVK Warrant are subject to adjustment in the event of specified events, including a reclassification of the Company’s common stock, a subdivision or combination of the Company’s common stock, or in the event of specified dividend payments. The KVK Warrant is exercisable until October 24, 2023. Upon exercise, the aggregate exercise price may be paid, at KVK’s election, in cash or on a net issuance basis, based upon the fair market value of the Company’s common stock at the time of exercise.

 

The Company determined that, since KVK qualifies as a customer under ASC 606, the KVK Warrant should be recorded as a contract asset and recognized as contra-revenue as the Company recognizes revenue from the APADAZ License Agreement. In addition, the Company determined that the KVK Warrant qualifies as a derivative under ASC 815 and should be recorded as a liability and stated at fair value each reporting period. The Company calculates the fair value of the KVK Warrant using a probability-weighted Black-Scholes option pricing model. Changes in fair value resulting from changes in the inputs to the Black Scholes model are accounted for as changes in the fair value of the derivative under ASC 815 and are recorded as fair value adjustment related to derivative and warrant liability in the condensed statements of operations. Changes in the number of shares that are expected to be issued are treated as changes in variable consideration under ASC 606 and are recorded as a change in contract asset in the condensed balance sheets.

 

28

 

 

 
G. Stock-Based Compensation

 

The Company maintains a stock-based compensation plan (the “Incentive Stock Plan”) that governs stock awards made to employees and directors prior to completion of the IPO.  

 

In November 2014, the Board of Directors of the Company ("the Board"), and in April 2015, the Company’s stockholders, approved the Company’s 2014 Equity Incentive Plan (the “2014 Plan”), which became effective in April 2015. The 2014 Plan provides for the grant of stock options, other forms of equity compensation, and performance cash awards. The maximum number of shares of common stock that may be issued under the 2014 Plan is 5,076,694 as of September 30, 2019. The number of shares of common stock reserved for issuance under the 2014 Plan will automatically increase on January 1 of each year, beginning on January 1, 2016, and ending on and including January 1, 2024, by 4% of the total number of shares of the Company’s capital stock outstanding on December 31 of the preceding calendar year, or a lesser number of shares determined by the Board. Pursuant to the terms of the 2014 Plan, on January 1, 2019, the common stock reserved for issuance under the 2014 Plan automatically increased by 1,058,214 shares.

 

During the second quarter of 2019, the Company granted to each non-employee member of the Company's board of directors (each a "non-employee Director") two separate fully vested restricted stock awards ("RSAs") under the 2014 Plan. The RSAs were granted in lieu of the quarterly cash compensation payable under the Company's Third Amended and Restated Non-Employee Director Compensation Policy to each non-employee Director for service as a member of the Company's board of directors, and applicable committees thereof, in the first and second quarters of 2019. For the first and second quarter of 2019, RSAs were granted for a total of 42,436 and 39,284 shares of common stock, respectively.

 

During the three months ended September 30, 2019 and 2018 and the nine months ended September 30, 2019, no stock options were exercised. During the nine months ended September 30, 2018, stock options were exercised for a total of 23,682 shares of common stock.

 

Stock-based compensation expense recorded under the Incentive Stock Plan and the 2014 Plan is included in the following line items in the accompanying condensed statements of operations (in thousands):

  

     Three months ended September 30,         Nine months ended September 30,
      2019     2018     2019   2018

Research and development

  $ 400     $ 409     $ 1,196     $ 1,196  

General and administrative

    657       941       2,468       2,813  
Severance expense           1,236             1,236  
Total stock-based compensation expense   $ 1,057     $ 2,586     $ 3,664     $ 5,245  

 

There was no stock-based compensation expense related to performance-based awards recognized during the three or nine months ended September 30, 2019 or 2018.

 

29

 

 

 
H. Fair Value of Financial Instruments

 

The accounting standard for fair value measurements provides a framework for measuring fair value and requires disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, based on the Company’s principal or, in absence of a principal, most advantageous market for the specific asset or liability.

 

The Company uses a three-tier fair value hierarchy to classify and disclose all assets and liabilities measured at fair value on a recurring basis, as well as assets and liabilities measured at fair value on a non-recurring basis, in periods subsequent to their initial measurement. The hierarchy requires the Company to use observable inputs when available, and to minimize the use of unobservable inputs, when determining fair value. The three tiers are defined as follows:

 

 

Level 1—Observable inputs that reflect quoted market prices (unadjusted) for identical assets or liabilities in active markets; 

 

Level 2—Observable inputs other than quoted prices in active markets that are observable either directly or indirectly in the marketplace for identical or similar assets and liabilities; and

 

Level 3—Unobservable inputs that are supported by little or no market data, which require the Company to develop its own assumptions.

 

The carrying amounts of certain financial instruments, including cash and cash equivalents, restricted cash and accounts payable and accrued expenses, approximate their respective fair values due to the short-term nature of such instruments.

 

The fair value of the Deerfield Convertible Note was $6.5 million and $6.2 million, respectively, as of September 30, 2019 and December 31, 2018. The fair value of the 2021 Notes was $57.9 million and $51.2 million, respectively, as of September 30, 2019 and December 31, 2018. Both the Deerfield Convertible Note and 2021 Notes fall within Level 3 of the fair value hierarchy as their value is based on the credit worthiness of the Company, which is an unobservable input. The Company used a Tsiveriotis-Fernandes model to value the Deerfield Convertible Note and 2021 Notes as of September 30, 2019 and December 31, 2018.

 

30

 

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The Company evaluates its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level in which to classify them for each reporting period. This determination requires significant judgments to be made. The following table summarizes the conclusions reached regarding fair value measurements as of September 30, 2019 and December 31, 2018 (in thousands):

 

   

Balance as of

September 30,

2019

 

Quoted Prices

in Active

Markets for

Identical Assets

(Level 1)

 

Significant 

Other

Observable

Inputs

(Level 2)

 

Significant

Unobservable

Inputs

(Level 3)

Deerfield Warrant liability

  $ 192     $     $  —     $ 192  

Embedded Warrant Put Option

    77              —        77  

Fundamental change and make-whole interest provisions embedded in 2021 Notes

                 —        —  
Deerfield Note Conversion Feature                        
KVK Warrant liability     66             66        

Total liabilities

  $ 335     $      66     269  

 

   

Balance as of

December 31,

2018

 

Quoted Prices

in Active

Markets for

Identical Assets

(Level 1)

 

Significant

Other

Observable

Inputs

(Level 2)

 

Significant

Unobservable

Inputs

(Level 3)

Deerfield Warrant liability

  $ 1,557     $     $     $ 1,557  

Embedded Warrant Put Option

    154                   154  
Fundamental change and make-whole interest provisions embedded in 2021 Notes                        

Deerfield Note Conversion Feature

    134                   134  
KVK Warrant liability     273             273        

Total liabilities

  $ 2,118     $     $ 273     $ 1,845  
                                 

Trading securities:

                               

Certificates of deposit

  $ 246     $ 246     $     $  

U.S. Treasury securities

    3,014       3,014              

Total assets

  $ 3,260     $ 3,260     $     $  

 

31

 

 

The Company’s Deerfield Warrant liability, embedded Warrant Put Option, the fundamental change and the make-whole interest provisions embedded in the 2021 Notes and the embedded Deerfield Note Put Option, as well as the trading securities are measured at fair value on a recurring basis. As of September 30, 2019 and December 31, 2018, the Deerfield Warrant liability, embedded Warrant Put Option, the fundamental change and make-whole interest provisions embedded in the 2021 Notes and the embedded Deerfield Note Put Option are reported on the condensed balance sheets in derivative and warrant liability. As of December 31, 2018, the trading securities are reported on the condensed balance sheets in marketable securities. The Company used a Monte Carlo simulation to value the Deerfield Warrant liability, embedded Warrant Put Option, the fundamental change and make-whole interest provisions embedded in the 2021 Notes, and the embedded Deerfield Note Put Option as of September 30, 2019 and December 31, 2018. Significant unobservable inputs used in measuring the fair value of these financial instruments included the Company’s estimated enterprise value, an estimate of the timing of a liquidity or fundamental change event and a present value discount rate. Changes in the fair value of the Deerfield Warrant liability, embedded Warrant Put Option, the fundamental change and make-whole interest provisions embedded in the 2021 Notes and the embedded Deerfield Note Put Option are reflected in the condensed statements of operations for the three and nine months ended September 30, 2019 and 2018 as a fair value adjustment related to derivative and warrant liability.

 

The Company’s KVK Warrant liability is measured at fair value on a recurring basis. As of September 30, 2019 and December 31, 2018, the KVK Warrant liability is reported on the condensed balance sheets in derivative and warrant liability. The Company estimates the fair value of the KVK Warrant using a probability-weighted Black-Scholes option-pricing model, which requires the use of subjective assumptions, including the expected term of the warrant, the expected stock price volatility, expected dividend yield and the risk-free interest rate for the expected term of the warrant. The expected term represents the period of time the warrant is expected to be outstanding. For the KVK Warrant, the Company used an expected term equal to the contractual term of the warrant. Expected volatility is based on the Company's historical volatility since the IPO. The Company assumes no dividend yield because dividends are not expected to be paid in the near future, which is consistent with the Company’s history of not paying dividends. Changes in the fair value of the KVK Warrant liability are reflected in the statements of operations for the three and nine months ended September 30, 2019 as a fair value adjustment related to derivative and warrant liability. The changes in the fair value of the KVK Warrant liability are not reflected in the condensed statements of operations for the three and nine months ended September 30, 2018 since it was not issued until October 2018.

 

A reconciliation of the beginning and ending balances for the derivative and warrant liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is as follows (in thousands):

   

    Three months ended September 30,   Nine months ended September 30,
    2019     2018   2019     2018

Balance as of beginning of period

  $ 1,437     $ 11,888     $ 1,845     $ 7,709  

Adjustment to fair value

    (1,168 )     (4,468     (1,576 )     (289 )

Balance as of end of period

  $ 269     $ 7,420     $ 269     $ 7,420  

 

32

 

 

 
I. Net Income (Loss) Per Share of Common Stock

 

Under the two-class method, for periods with net income, basic net income per share of common stock is computed by dividing the net income attributable to shares of common stock by the weighted average number of shares of common stock outstanding during the period. Net income attributable to shares of common stock is computed by subtracting from net income the portion of current period earnings that participating securities would have been entitled to receive pursuant to their dividend rights had all of the period’s earnings been distributed. No such adjustment to earnings is made during periods with a net loss as the holders of the participating securities have no obligation to fund losses. Diluted net income (loss) per share of common stock is computed under the two-class method by using the weighted average number of shares of common stock outstanding plus the potential dilutive effects of stock options and warrants. In addition, the Company analyzes the potential dilutive effect of the outstanding convertible securities under the if-converted method when calculating diluted income (loss) per share of common stock in which it is assumed that the outstanding convertible securities convert into common stock at the beginning of the period or date of issuance, if the convertible security was issued during the period. The Company reports the more dilutive of the approaches (two-class or if-converted) as its diluted net income (loss) per share of common stock during the period.

 

Diluted net loss per share of common stock is the same as basic net loss per share of common stock for the nine months ended September 30, 2019 and the three and nine months ended September 30, 2018 because the effects of potentially dilutive items were anti-dilutive for the respective periods. The following securities, presented on a common stock equivalent basis, have been excluded from the calculation of weighted average number of shares of common stock outstanding because their effect is anti-dilutive:

 

    Three months ended September 30,   Nine months ended September 30,
    2019   2018   2019   2018

Warrants to purchase common stock

    500,000       2,027,763       2,423,077       2,027,763  

Awards under equity incentive plans

    4,620,891       3,707,421       4,620,891       3,707,421  

Deerfield Convertible Note

    1,192,918       1,167,607       1,192,918       1,167,607  

2021 Notes*

    31,166,835       5,040,914       31,166,835       5,040,914  
Series A Preferred Stock                 1,112,334        
Series B-1 Preferred Stock                 831,051        

Total securities excluded from the calculation of weighted average number of shares of common stock outstanding

    37,480,644       11,943,705       41,347,106       11,943,705  

 

* Inclusive of 28,439,015 of shares of Common Stock issuable (i) in exchange of the Optional Exchange Principal Amount, or (ii) upon conversion of the Series B-2 Preferred Stock issuable in exchange of the Optional Exchange Principal Amount.

 

The following table reconciles basic net income per share of common stock to diluted net income per share of common stock for the three months ended September 30, 2019 (in thousands, except per share data):

 

   

Three months ended

 
   

September 30, 2019

 

Basic net income per share of common stock:

       

Net income

  $ 3,063

 

Less: Net income attributable to participating securities

    (348

Net income attributable to shares of common stock

    2,715

 

Less: Dividends declared or accumulated

     

Undistributed net income attributable to shares of common stock, basic

  $ 2,715

 

Weighted average number of shares of common stock outstanding

    30,127  

Basic net income per share of common stock

  $ 0.09

 

Diluted net income per share of common stock:

       

Net income

  $ 3,063

 

Less: Fair value adjustment income related to Deerfield Warrant liability

    (1,019

)

Less: Fair value adjustment income related to embedded Warrant Put Option

    (135

)

Net income attributable to shares of common stock, diluted

  $ 1,909

 

Weighted average number of shares of common stock outstanding

    30,127  

Dilutive effect of Deerfield Warrant

     
Dilutive effect of Series A Preferred     1,112  

Dilutive effect of Series B-1 Preferred

    433  

Weighted average number of shares of common stock outstanding, diluted

    31,672  

Diluted net income per share of common stock

  $ 0.06

 

 

 

J.

Severance Expense

 

In August 2018, Daniel L. Cohen resigned from his position as the executive vice president, government and public relations of the Company, effective immediately. In connection with his resignation, Mr. Cohen and the Company entered into a separation and release agreement which included among other items, severance benefits. The severance benefits consisted of personnel and other related charges of approximately $0.4 million and stock compensation expense of approximately $1.2 million related to the acceleration of vesting on unvested shares subject to certain stock options and the extension of the exercise period for certain stock options. These severance benefits are presented as severance expense in the condensed statements of operations. As of September 30, 2018, the Company had accrued severance expense recorded within accounts payable and accrued expenses in the amount of $0.3 million. As of and for the three and nine months ended September 30, 2019 there was no severance expense or accrued severance expense.

 

33

 
 
 
K. Leases

 

We have operating and finance leases for office space, laboratory facilities and various laboratory equipment, furniture and office equipment and leasehold improvements. Our leases have remaining lease terms of 1 year to 6 years, some of which include options to extend the leases for up to 5 years, and some which include options to terminate the leases within 1 year.

 

The components of lease expense were as follows (in thousands): 

 

    Three months ended September 30,   Nine months ended September 30,
Lease Cost   2019   2019
Finance lease cost:                
Amortization of right-of-use assets   $ 31     $ 92  
Interest on lease liabilities     9       31  
Total finance lease cost     40       123  
Operating lease cost     124       372  
Short-term lease cost     58       173  
Variable lease cost     14       35  
Less: sublease income     (25 )     (75 )
Total lease costs   $ 211     $ 628  

 

Supplemental cash flow information related to leases was as follows (in thousands):

 

    Nine months ended September 30,
    2019
Cash paid for amounts included in the measurement of lease liabilities:         
Operating cash flows from finance leases   $ 31  
Financing cash flows from finance leases     157  
Operating cash flows from operating leases     326  
Operating cash flows from short-term leases    

173

 
Operating cash flows from variable lease costs     35  
         
Right-of-use assets obtained in exchange for lease liabilities:        
Finance leases   $ 737  
Operating leases     1,852  

 

34

 

 

Supplemental balance sheet information related to leases was as follows (in thousands, except weighted average remaining lease term and weighted average discount rate):

 

    September 30,  
    2019  
Finance Leases        
Property and equipment, at cost   $ 1,013  
less: accumulated depreciation and amortization     (368 )
Property and equipment, net   $ 645  
         
Other current liabilities   $ 227  
Other long-term liabilities     227  
Total finance lease liabilities   $ 454  
         
Operating Leases        
Operating lease right-of-use assets   $ 1,649  
Total operating lease right-of-use assets   $ 1,649  
         
Current portion of operating lease liabilities   $ 369  
Operating lease liabilities, less current portion     1,976  
Total operating lease liabilities   $ 2,345  
         
Weighted Average Remaining Lease Term        
Finance leases   2 years
Operating leases   6 years
         
Weighted Average Discount Rate        
Finance leases     7.7 %
Operating leases     7.5 %

 

Maturities of lease liabilities were as follows (in thousands):

 

    Finance   Operating
Year Ending December 31,   Leases   Leases
2019 (excluding the nine months ended September 30, 2019)   $ 66     $ 144  
2020     251       499  
2021     163       449  
2022     11       461  
2023           472  
Thereafter           903  
Total lease payments     491       2,928  
Less: future interest expense     (37 )     (583 )
Lease liabilities   $ 454     $ 2,345  

 

35

 

 

 

 

Item 2.

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

 

You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the “Risk Factors” section of this Quarterly Report on Form 10-Q, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

 

Unless the context otherwise requires, we use the terms “KemPharm,” “Company,” “we,” “us” and “our” in this Quarterly Report on Form 10-Q to refer to KemPharm, Inc. We have proprietary rights to a number of trademarks used in this Quarterly Report on Form 10-Q that are important to our business, including KemPharm, APADAZ, LAT and the KemPharm logo. All other trademarks, trade names and service marks appearing in this Quarterly Report on Form 10-Q are the property of their respective owners. Solely for convenience, the trademarks and trade names in this Quarterly Report on Form 10-Q are referred to without the ® and ™ symbols, but such references should not be construed as any indicator that their respective owners will not assert, to the fullest extent under applicable law, their rights thereto.

 

36

 

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q, including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933, as amended, or the Securities Act, and the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “would,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “assume,” “intend,” “potential,” “continue” or other similar words or the negative of these terms. We have based these forward-looking statements largely on our current expectations about future events and financial trends that we believe may affect our business, financial condition and results of operations. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in “Risk Factors” and elsewhere in this report. Accordingly, you should not place undue reliance upon these forward-looking statements. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur, the timing of events and circumstances and actual results could differ materially from those anticipated in the forward-looking statements. Forward-looking statements contained in this report include, but are not limited to, statements about:

 

  our development plan for our ADHD product candidates, including expectations about the timing of our regulatory filings;
     

 

the progress of, timing of and expected amount of expenses associated with our research, development and commercialization activities;

     
  the sufficiency of our cash resources to fund our operating expenses and capital investment requirements for any period;
     

 

the expected timing of our clinical trials for our product candidates and the availability of data and result of those trials;

     

 

our expectations regarding federal, state and foreign regulatory requirements;

     

 

the potential therapeutic benefits and effectiveness of our product candidates and partnered assets;

     

 

the size and characteristics of the markets that may be addressed by our product candidates and partnered assets;

     

 

the potential outcome of any strategic collaborations or partnerships for the development or sale of our product candidates and partnered assets;

     

 

our expectations as to future financial performance, expense levels and liquidity sources; and

     

 

the timing of commercializing our product candidates and partnered assets.

 

The forward-looking statements made in this report relate only to events as of the date on which the statements are made. We have included important factors in the cautionary statements included in this report, particularly in the section entitled “Risk Factors” that we believe could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. Except as required by law, we do not assume any intent to update any forward-looking statements after the date on which the statement is made, whether as a result of new information, future events or circumstances or otherwise.

  

37

 

 

Overview

 

We are a specialty pharmaceutical company focused on the discovery and development of proprietary prodrugs to treat serious medical conditions through our proprietary Ligand Activated Therapy, or LAT™, technology. We utilize our proprietary LAT technology to generate improved prodrug versions of drugs approved by the U.S. Food and Drug Administration, or FDA, as well as to generate prodrug versions of existing compounds that may have applications for new disease indications. Our product candidate pipeline is focused on the high need areas of attention deficit hyperactivity disorder, or ADHD, and stimulant use disorder, or SUD. Our co-lead clinical development candidates, KP415 and KP484, are both based on a prodrug of d-methylphenidate, or d-MPH, but with differing extended-release, or ER, effect profiles, and are intended for the treatment of ADHD. Our preclinical product candidate for the treatment of SUD is KP879, based on a prodrug of d-MPH. In addition, we have announced our commercial partnership with KVK Tech, Inc., or KVK, of APADAZ®, an FDA approved immediate-release, or IR, combination product of benzhydrocodone, our prodrug of hydrocodone, and acetaminophen, or APAP, for the short-term (no more than 14 days) management of acute pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate. We have entered into a collaboration and license agreement with Commave Therapeutics SA, an affiliate of Gurnet Point Capital, or Commave, for the development, manufacture and commercialization of our product candidates containing serdexmethylphenidate, or SDX, and d-MPH.

 

In September 2019, we entered into a Collaboration and License Agreement, or the KP415/484 License Agreement, with Commave. Under the KP415/484 License Agreement, we granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize our product candidates containing SDX and d-MPH, including KP415, KP484, and, at the option of Commave, KP879, KP922 or any other product candidate developed by us containing SDX and developed to treat ADHD or any other central nervous system disorder.

 

We expect that our only source of revenues will be through payments arising from our license agreements with KVK and Commave, and/or through any other future arrangements related to one of our other product candidates. To date, we have only generated revenue from the KP415/484 License Agreement in the form of the non-refundable upfront payment of $10.0 million, reimbursement of out-of-pocket third-party research and development costs and payments related to the performance of consulting services. We had negative cash flows from operations since our inception and, as of September 30, 2019, had an accumulated deficit of $239.7 million and a net working capital (current assets less current liabilities) deficit of $1.7 million. Our negative cash flows from operations for the nine months ended September 30, 2019 and 2018 were $20.6 million and $39.2 million, respectively.

 

We expect to continue to incur significant expenses and negative operating cash flows for the foreseeable future, and those expenses and losses may fluctuate significantly from quarter-to-quarter and year-to-year. We anticipate that our expenses will fluctuate substantially as we:

 

 

continue our ongoing preclinical studies, clinical trials and our product development activities for our pipeline of product candidates;

 

 

 

 

seek regulatory approvals for any product candidates that successfully complete clinical trials;

 

 

 

 

continue research and preclinical development and initiate clinical trials of our other product candidates;

 

 

 

 

seek to discover and develop additional product candidates either internally or in partnership with other pharmaceutical companies;

 

 

 

 

adapt our regulatory compliance efforts to incorporate requirements applicable to marketed products;

 

 

 

 

maintain, expand and protect our intellectual property portfolio; and

 

 

 

 

incur additional legal, accounting and other expenses in operating as a public company.

 

Our commercial revenue, if any, will be derived from sales of APADAZ or any other product candidates for which we obtain regulatory approval. In October 2018, we entered into a collaboration and license agreement, or the APADAZ License Agreement, with KVK, pursuant to which we granted an exclusive license to KVK to commercialize APADAZ in the United States, and in September 2019, we entered into the KP415/484 License Agreement, pursuant to which we granted an exclusive, worldwide license to Commave to develop, manufacture and commercialize our product candidates containing SDX and d-MPH, including KP415 and KP484. We cannot guarantee that KVK or Commave will be able to successfully commercialize APADAZ or our product candidates covered under the KP415/484 License Agreement, or that we will ever receive any payments under the APADAZ License Agreement from commercial sales of APADAZ or any future payments under the KP415/484 License Agreement. We also do not know when, if ever, any other product candidate will be commercially available. Accordingly, we will need to continue to rely on additional financing to achieve our business objectives. Adequate additional financing may not be available to us on acceptable terms, or at all. To the extent that we raise additional capital through the sale of equity or debt, the terms of these securities may restrict our ability to operate. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights. If we are unable to raise capital when needed or on attractive terms, we could be forced to delay, reduce or altogether cease our research and development programs or future commercialization efforts.

    

38

 

 

Our Partnered Product Candidates and Product

 

We have employed our proprietary LAT technology to create a portfolio of product candidates and product that we believe will offer significant improvements over FDA-approved and widely-prescribed drugs.

 

Our pipeline of partnered assets is summarized in the table below:

 

KemPharm Partnered Assets

 

 

 

Product

 

Development

 

Key

Indication / Parent Drug

 

Candidate

 

Status

 

Milestone

ADHD

 

 

 

 

 

 

Methylphenidate (ER)

 

KP415

 

Clinical

 

NDA Submission - Q4 2019

Methylphenidate (ER)   KP484   Clinical  

NDA Submission - 2020

Pivotal Efficacy Trial Data - 2020

SUD

 

 

 

 

 

 

Methylphenidate (ER)*

 

KP879

 

Preclinical

 

 

 

            Key
Product Name           Milestone
APADAZ           Commercial Launch - November 2019

 

* This product candidate is subject to an option in favor of Commave under the terms of the KP415/484 License Agreement, but is not currently licensed to Commave thereunder.

 

Subject to Commave's approval, we intend to seek approval of KP415 and KP484 under the 505(b)(2) NDA pathway, which will allow us to rely on the FDA's previous findings of safety and effectiveness for one or more approved products. We anticipate submitting a 505(b)(2) NDA for KP415 in the fourth quarter of 2019 and reporting additional pharmacokinetic, or PK, and pivotal efficacy trial data and submitting a 505(b)(2) NDA for KP484 in 2020.

 

In September 2019, we entered into the KP415/484 License Agreement with Commave. Under the KP415/484 License Agreement, we granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize our product candidates containing SDX and d-MPH, including KP415, KP484, and, at the option of Commave, KP879, KP922 or any other product candidate developed by us containing SDX and developed to treat ADHD or any other central nervous system disorder.

 

In October 2018, we entered into the APADAZ License Agreement with KVK pursuant to which we have granted an exclusive license to KVK to conduct regulatory activities for, manufacture and commercialize APADAZ in the United States. Under the terms of the APADAZ License Agreement we are eligible to receive milestone payments of up to $53.0 million and royalties based on the net profits of APADAZ sales in the United States. We anticipate that KVK’s commercialization strategy will target outreach to pharmacy benefit managers, managed care organizations and integrated delivery networks for the exclusive utilization of APADAZ as an alternative to currently available hydrocodone/acetaminophen products. In November 2019, APADAZ and its authorized generic (AG-APADAZ) became nationally available. In support of this commercial launch, we have begun the technology transfer process outlined under the APADAZ License Agreement. As part of this process, in February 2019 we completed the transfer of the NDA for APADAZ to KVK.

 

39

 

 

Third-Party Agreements

 

APADAZ License Agreement

 

In October 2018, we entered into the APADAZ License Agreement with KVK pursuant to which we have granted an exclusive license to KVK to conduct regulatory activities for, manufacture and commercialize APADAZ in the United States.

 

Pursuant to the APADAZ License Agreement, KVK has agreed to pay us pre-launch payments and cost reimbursements of an estimated $3.4 million, which includes a pre-launch payment of $2.0 million within 10 days of the achievement of a specified milestone related to the initial formulary adoption of APADAZ, or the Initial Adoption Milestone. In addition, KVK has agreed to make additional payments to us upon the achievement of specified sales milestones of up to $53.0 million in the aggregate. Further, we and KVK will share the quarterly net profits of APADAZ by KVK in the United States at specified tiered percentages, ranging from us receiving 30% to 50% of net profits, based on the amount of net sales on a rolling four quarter basis. We are responsible for a portion of commercialization and regulatory expenses for APADAZ until the Initial Adoption Milestone is achieved, after which KVK will be responsible for all expenses incurred in connection with commercialization and maintaining regulatory approval in the United States.

 

The APADAZ License Agreement will terminate on the later of the date that all of the patent rights for APADAZ have expired in the United States or KVK’s cessation of commercialization of APADAZ in the United States. KVK may terminate the APADAZ License Agreement upon 90 days written notice if a regulatory authority in the United States orders KVK to stop sales of APADAZ due to a safety concern. In addition, after the third anniversary of the APADAZ License Agreement, KVK may terminate the Agreement without cause upon 18 months prior written notice. We may terminate the APADAZ License Agreement if KVK stops conducting regulatory activities for or commercializing APADAZ in the United States for a period of six months, subject to specified exceptions, or if KVK or its affiliates challenge the validity, enforceability or scope of any licensed patent under the APADAZ License Agreement. Both parties may terminate the APADAZ License Agreement (i) upon a material breach of the APADAZ License Agreement, subject to a 30-day cure period, (ii) the other party encounters bankruptcy or insolvency or (iii) if the Initial Adoption Milestone is not achieved. Upon termination, all licenses and other rights granted by us to KVK pursuant to the APADAZ License Agreement would revert to us.

 

The APADAZ License Agreement also establishes a joint steering committee, which will monitor progress in the development and commercialization of APADAZ.

 

40

 

 

KP415/484 License Agreement

 

In September 2019, we entered into the KP415/484 License Agreement with Commave. Under the KP415/484 License Agreement, we granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize our product candidates containing SDX and d-MPH, including KP415, KP484, and, at the option of Commave, KP879, KP922 or any other product candidate developed by us containing SDX and developed to treat ADHD or any other central nervous system disorder, or the Additional Product Candidates and, collectively with KP415 and KP484, the Licensed Product Candidates.

 

Under the terms of the KP415/484 License Agreement, we granted Commave an exclusive, worldwide license to commercialize and develop the Licensed Product Candidates; provided that such license shall apply to an Additional Product Candidates only if Commave exercises its option under the KP415/484 License Agreement related thereto. If Commave exercises its option related to any Additional Product Candidate under the KP415/484 License Agreement, the parties are obligated to negotiate in good faith regarding the economic terms of such Additional Product Candidate. We also granted to Commave a right of first refusal to acquire, license or commercialize any Additional Product Candidate, with such right of first refusal expiring upon the acceptance of a new drug application for such Additional Product Candidate. We also granted Commave a right of first negotiation and a right of first refusal, subject to specified exceptions, for any assignment of our rights under the KP415/484 License Agreement.

 

Pursuant to the KP415/484 License Agreement, Commave paid the Company an upfront payment of $10,000,000 and agreed to pay up to $63,000,000 in milestone payments upon the occurrence of specified regulatory milestones related to the KP415 and KP484. In addition, Commave agreed to make additional payments upon the achievement of specified U.S. sales milestones of up to $420,000,000 in the aggregate, depending, among other things, on timing of approval for a new drug applicable for KP415 and its final approved label, if any. Further, Commave will pay us quarterly, tiered royalty payments ranging from a percentage in the high single digits to the mid-twenties of Net Sales (as defined in the KP415/484 License Agreement) in the United States and a percentage in the low to mid-single digits of Net Sales in each country outside the United States, in each case subject to specified reductions under certain conditions as described in the KP415/484 License Agreement. Commave is obligated to make such royalty payments on a product-by-product basis until expiration of the Royalty Term (as defined in the KP415/484 License Agreement) for the applicable product.

 

Commave agreed to be responsible for and reimburse us for all of development, commercialization and regulatory expenses for the Licensed Product Candidates, subject to certain limitations as set forth in the KP415/484 License Agreement.

 

The KP415/484 License Agreement will continue on a product-by-product basis (i) until expiration of the Royalty Term for the applicable Licensed Product Candidate in the United States and (ii) perpetually for all other countries. Commave may terminate the KP415/484 License Agreement at its convenience upon prior written notice prior to regulatory approval of any Licensed Product Candidate or upon prior written notice after regulatory approval of any Licensed Product Candidate. We may terminate the KP415/484 License Agreement in full if Commave, any of its sublicensees or any of its or their affiliates challenge the validity of any Licensed Patent (as defined in the KP415/484 License Agreement) and such challenge is not required under a court order or subpoena and is not a defense against a claim, action or proceeding asserted by us. Either party may terminate the KP415/484 License Agreement (i) upon a material breach of the KP415/484 License Agreement by the other party, subject to a cure period, or (ii) if the other party encounters bankruptcy or insolvency. Upon a Serious Material Breach (as defined in the KP415/484 License Agreement) by us, subject to a cure period, Commave may choose not to terminate the KP415/484 License Agreement and instead reduce the milestone and royalty payments owed to us. Upon termination, all licenses and other rights granted by us to Commave pursuant to the KP415/484 License Agreement would revert to us. During the term of the KP415/484 License Agreement, we may not develop or commercialize any Competing Product (as defined in the KP415/484 License Agreement).

 

The KP415/484 License Agreement also establishes a joint steering committee, which will monitor progress in the development of the KP415 and KP484. Subject to the oversight of the joint steering committee, we otherwise retain all responsibility for the conduct of all regulatory activities required to obtain new drug application approval of KP415 and KP484; provided that Commave shall be the sponsor of any clinical trials conducted by the us on behalf of Commave.

 

41

 

 

JMI Agreement

 

In November 2009, we entered into a supply agreement with Johnson Matthey Inc., or JMI, whereby JMI has agreed to supply us with all the benzhydrocodone necessary for clinical trials and commercial sale for a price equal to JMI's manufacturing cost and to provide process optimization and development services for benzhydrocodone. In exchange, we issued shares of our common stock to JMI, provided that the commercial supply arrangement for benzhydrocodone would be exclusive to JMI in the United States and agreed to pay JMI royalties on the net sales of any products that utilize benzhydrocodone as the API. The percentage royalty rate ranges from the high teens at low volumes to the mid-single digits at higher volumes. Our FDA-approved drug, APADAZ, contains benzhydrocodone.

 

We are responsible for all costs of any benzhydrocodone manufactured during a specified validation process for APADAZ. After completion of the validation process, but prior to the commercial launch of any products that utilize benzhydrocodone as the active pharmaceutical ingredient, or API, JMI will manufacture batches of benzhydrocodone at a price to be negotiated. Failure to agree upon this pricing would result in JMI supplying these batches to us free of charge and we would pay JMI an additional royalty payment on such batches. The percentage royalty rate ranges from the low teens at low volumes to the low single digits at higher volumes and is additive to any minimum royalty we may owe JMI on such batch. JMI will manufacture and supply benzhydrocodone at a price equal to JMI's fully allocated manufacturing cost after commercial launch of APADAZ.

 

We must purchase all our U.S. benzhydrocodone needs from JMI and JMI cannot supply benzhydrocodone to other companies. After the commercial launch of any product that utilizes benzhydrocodone as the API, JMI is required to identify a secondary manufacturing site and qualify and validate that site to produce benzhydrocodone.

 

The term of the supply agreement extends as long as we hold a valid and enforceable patent for benzhydrocodone or until the tenth anniversary of the commercial launch of any product that utilizes benzhydrocodone as the API, whichever date is later. Upon the expiration of such term, the agreement will automatically renew for a period of two years unless either party provides 12 months' prior notice of its intent not to renew.

 

Other Third-Party Agreements

 

Under our March 2012 asset purchase agreement with Shire Pharmaceuticals, LLC, or Shire, Shire had a right of first refusal to acquire, license or commercialize KP415 and KP484. In early 2019, Shire was acquired by Takeda Pharmaceutical Company, Ltd, or Takeda, who took over this right of first refusal at that time. Takeda did not exercise this right of first refusal as part of the KP415/484 License Agreement discussed above.

 

Under our March 2012 termination agreement with Aquestive Therapeutics, or Aquestive, Aquestive has the right to receive a royalty amount equal to 10% of any value generated by KP415, KP484 or KP879, and any product candidates arising therefrom, including royalty payments on any license of KP415, KP484 or KP879, the sale of KP415, KP484 or KP879 to a third party, the commercialization of KP415, KP484 or KP879 and the portion of any consideration that is attributable to the value of KP415, KP484 or KP879 and paid to us or our stockholders in a change of control transaction. In connection with the KP415/484 License Agreement Aquestive received a royalty equal to 10% of the upfront license payment from us.

 

42

 

 

Results of Operations

 

Comparison of the three months ended September 30, 2019 and 2018 (in thousands):

 

   

Three months ended September 30,

 

Period-to-

   

2019

 

2018

 

Period Change

Revenue

  $ 11,463     $     $ 11,463  

Operating expenses:

                       
Cost of revenue     1,000             1,000  

Research and development

    3,616       13,330       (9,714 )

General and administrative

    3,613       2.992       621  
Severance expense           1,636       (1,636 )

Total operating expenses

    8,229       17,958       (9,729 )

Income (loss) from operations

    3,234       (17,958 )     21,192  

Other (expense) income:

                       

Interest expense related to amortization of debt issuance costs and discount

    (371 )     (326 )     (45 )

Interest expense on debt principal

    (1,208 )     (1,367 )     159  

Fair value adjustment related to derivative and warrant liability

    1,351       4,468       (3,117 )

Interest and other income, net

    60       52       8  

Total other (expense) income

    (168 )     2,827       (2,995 )

Income (loss) before income taxes

    3,066       (15,131 )     18,197  

Income tax (expense) benefit

    (3 )     60       (63 )

Net income (loss)

  $ 3,063     $ (15,071 )   $ 18,134  

 

Net Income (Loss)

 

Net income for the three months ended September 30, 2019 was $3.1 million, an increase of $18.1 million compared to a net loss for the three months ended September 30, 2018 of $15.1 million. The increase was primarily attributable to an increase in income from operations of $21.2 million and a decrease in net interest expense and other items of $0.1 million; partially offset by a change in fair value adjustment related to a decrease of $1.4 million in the derivative and warrant liability compared to a decrease in this liability of $4.5 million in the prior-year period.

 

Revenue

 

Revenue for the three months ended September 30, 2019 was $11.5 million, which was comprised of a $10.0 million non-refundable up-front payment, $1.2 million of reimbursements for out-of-pocket third-party research and development costs and $0.3 million of consulting fees earned, all related to the KP415/484 License Agreement.

 

Cost of Revenue

 

Cost of revenue for the three months ended September 30, 2019 was $1.0 million, which was comprised of a royalty payment to Aquestive related to the $10.0 million non-refundable upfront payment under the KP415/484 License Agreement.

 

Research and Development

 

Research and development expenses decreased by $9.7 million, from $13.3 million for the three months ended September 30, 2018, to $3.6 million for the three months ended September 30, 2019. This decrease was primarily attributable to a decrease in net third-party research and development costs.

 

General and Administrative

 

General and administrative expenses increased by $0.6 million, from $3.0 million for the three months ended September 30, 2018, to $3.6 million for the three months ended September 30, 2019. This increase was primarily attributable to an increase in professional fees; partially offset by a decrease in personnel-related costs and other miscellaneous general and administrative costs.

 

Severance Expense

 

Severance expense of $1.6 million was recognized for the three months ended September 30, 2018 due to the resignation of our executive vice president, government and public relations in August 2018. Severance expense is comprised of $0.4 million of personnel and other related charges and $1.2 million of stock compensation expense related to the acceleration of vesting on certain stock options upon employee termination.

 

Other (Expense) Income

 

We had other expense of $0.2 million for the three months ended September 30, 2019 compared to other income of $2.8 million for the three months ended September 30, 2018. This period-to-period change was primarily attributable to the change in the fair value adjustment related to changes in derivative and warrant liability.

 

43

 

 

Comparison of the nine months ended September 30, 2019 and 2018 (in thousands):

 

   

Nine months ended September 30,

 

Period-to-

   

2019

 

2018

 

Period Change

Revenue

 

$

11,463

   

$

   

$

11,463

 

Operating expenses:

                       
Cost of revenue     1,000             1,000  

Research and development

   

16,950

     

35,455

     

(18,505

)

General and administrative

   

9,440

     

9,544

     

(104

)

Severance expense           1,636       (1,636 )

Total operating expenses

   

27,390

     

46,635

     

(19,245

)

Loss from operations

   

(15,927

)

   

(46,635

)

   

30,708

 

Other (expense) income:

                       

Interest expense related to amortization of debt issuance costs and discount

   

(981

)

   

(1,106

)

   

125

 

Interest expense on debt principal

   

(3,669

)

   

(4,228

)

   

559

 

Fair value adjustment related to derivative and warrant liability

   

1,783

     

289

 

   

1,494

 

Interest and other income, net

   

295

     

290

     

5

 

Total other (expense) income

   

(2,572

)

   

(4,755

)

   

2,183

 

Loss before income taxes

   

(18,499

)

   

(51,390

)

   

32,891

 

Income tax benefit

   

14

     

107

     

(93

)

Net loss

 

$

(18,485

)

 

$

(51,283

)

 

$

32,798

 

 

Net Loss

 

Net loss for the nine months ended September 30, 2019 was $18.5 million, a decrease of $32.8 million compared to net loss for the nine months ended September 30, 2018 of $51.3 million. The decrease was primarily attributable to a decrease in loss from operations of $30.7 million, a change in fair value adjustment related to a decrease of $1.8 million in the derivative and warrant liability compared to a decrease in this liability of $0.3 million in the prior-year period and a decrease in net interest expense and other items of $0.6 million.

 

Revenue

 

Revenue for the nine months ended September 30, 2019 was $11.5 million, which was comprised of a $10.0 million non-refundable upfront payment, $1.2 million of reimbursements for out-of-pocket third-party research and development costs and $0.3 million of consulting fees earned, all related to the KP415/484 License Agreement.

 

Cost of Revenue

 

Cost of revenue for the nine months ended September 30, 2019 was $1.0 million, which was comprised of a royalty payment to Aquestive related to the $10.0 million non-refundable upfront payment under the KP415/484 License Agreement.

 

Research and Development

 

Research and development expenses decreased by $18.5 million, from $35.5 million for the nine months ended September 30, 2018, to $17.0 million for the nine months ended September 30, 2019. This decrease was primarily attributable to a decrease in net third-party research and development costs and personnel-related costs.

 

General and Administrative

 

General and administrative expenses decreased by $0.1 million, from $9.5 million for the nine months ended September 30, 2018, to $9.4 million for the nine months ended September 30, 2019. This decrease was primarily attributable to a decrease in personnel-related costs and other miscellaneous general and administrative costs.

 

Other (Expense) Income

 

Other (expense) income decreased by $2.2 million, from expense of $4.8 million for the nine months ended September 30, 2018, to expense of $2.6 million for the nine months ended September 30, 2019. This period-to-period change was primarily attributable to the change in the fair value adjustment related to changes in derivative and warrant liability.

 

44

 

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

Through September 30, 2019, we have funded our research and development and operating activities primarily through the issuance of debt, private placements of redeemable convertible preferred stock and the sale of common stock in our initial public offering, or IPO, at-the-market offering, underwritten public offerings, through our purchase agreement, or the Purchase Agreement, with Lincoln Park Capital Fund, LLC, or Lincoln Park, and from revenue received under the KP415/484 License Agreement. As of September 30, 2019, we had cash and cash equivalents of $6.5 million and restricted cash of $0.5 million.

 

We filed a registration statement on Form S-3 covering the sale from time to time of up to $150.0 million of our common stock, preferred stock, debt and/or warrants, which was declared effective by the Securities and Exchange Commission, or SEC, on October 17, 2016, or the Current Registration Statement. In October 2019, the Company filed a registration on Form S-3 covering the sale of up to $80.0 million of the Company's common stock, preferred stock, and debt and/or warrants, or the Replacement Registration Statement. Once the Replacement Registration Statement is declared effective by the SEC, the Company will no longer make any sales under the Current Registration Statement.

 

Based on the market value of our outstanding common stock held by non-affiliates as of March 1, 2019, the date we filed our Annual Report on Form 10-K for the year ended December 31, 2018, in order to issue securities under the Current Registration Statement and the Replacement Registration Statement, once effective, we must rely on Instruction I.B.6. of Form S-3, which imposes a limitation on the maximum amount of securities that we may sell pursuant to the registration statements during any twelve-month period. At the time we sell securities pursuant to the applicable registration statement, the amount of securities to be sold plus the amount of any securities we have sold during the prior twelve months in reliance on Instruction I.B.6. may not exceed one-third of the aggregate market value of our outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale, as computed in accordance with Instruction I.B.6. This calculation was updated immediately after we filed our Annual Report on Form 10-K for the year ended December 31, 2018 on March 1, 2019. As of that date, the amount of securities we are able to sell under a registration statement on Form S-3 during a 12-month period was approximately $18.5 million, of which prospectus supplements were filed to register (i) approximately $15.3 million for sales under the Purchase Agreement, and (ii) approximately $3.2 million for sales under our Common Stock Sales Agreement, or the Second ATM Agreement, with RBC Capital Markets, LLC, or RBCCM. Based on this calculation, we expect that we will be unable to sell additional securities beyond those amounts pursuant to our Current Registration Statement or the Replacement Registration Statement, once effective, for a period of twelve months, unless and until the market value of our outstanding common stock held by non-affiliates increases significantly. In addition, under the terms of the Purchase Agreement, stockholder approval may be required to access a portion of the amounts available under the Purchase Agreement.

 

In September 2018, we entered into the Second ATM Agreement with RBCCM, under which we may offer and sell, from time to time, in our sole discretion, shares of common stock having an aggregate offering price of up to $50,000,000 through RBCCM as our sales agent. The registration statement on Form S-3 contemplated under the Second ATM Agreement includes a prospectus supplement covering the offering of up to $50,000,000 of shares of common stock in accordance with the Second ATM Agreement. In March 2019, we filed an updated prospectus supplement regarding the Second ATM Agreement covering the offering of up to $3.2 million of shares of common stock in order to be in compliance with Instruction I.B.6 of Form S-3. As of September 30, 2019, we have not sold any shares of common stock under the Second ATM Agreement.

 

In October 2018, we entered into an underwriting agreement with RBCCM pursuant to which we sold 8,333,334 shares of our common stock in an underwritten public offering pursuant to our registration statement on Form S-3. Our net proceeds from the offering were approximately $23.1 million after deducting underwriting discounts and commissions and estimated offering expenses.

 

In February 2019, we entered into the Purchase Agreement with Lincoln Park, which provides that, upon the terms and subject to the conditions and limitations set forth therein, we may sell to Lincoln Park up to $15.0 million of shares of our common stock, from time to time over the 36-month term of the Purchase Agreement, and upon execution of the Purchase Agreement we issued an additional 120,200 shares of our common stock to Lincoln Park as commitment shares in accordance with the closing conditions contained within the Purchase Agreement. Concurrently with entering into the Purchase Agreement, we also entered into a Registration Rights Agreement with Lincoln Park, pursuant to which we agreed to register the sale of the shares of our common stock that have been and may be issued to Lincoln Park under the Purchase Agreement pursuant to our existing shelf registration statement on Form S-3 or a new registration statement. As of September 30, 2019, we have sold 3,401,271 shares of our common stock to Lincoln Park under the Purchase Agreement for approximately $5.4 million in gross proceeds.

 

In September 2019, we entered into the KP415/484 License Agreement with Commave and Commave paid us a non-refundable upfront payment of $10.0 million.

 

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We had negative operating cash flows since our inception and, as of September 30, 2019, had an accumulated deficit of $239.7 million and a net working capital (current assets less current liabilities) deficit of $1.7 million. We anticipate that we will continue to incur negative operating flows for at least the next several years. Our recurring negative cash flows from operations, stockholders' deficit and net working capital deficit raise substantial doubt about our ability to continue as a going concern. We expect that our only source of revenues will be through payments arising from our license agreements with KVK and Commave, and/or through any other future arrangements related to one of our other product candidates. Accordingly, our ability to continue as a going concern may require us to obtain additional financing to fund our operations. The perception of our inability to continue as a going concern may make it more difficult for us to obtain financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees. Adequate additional financing may not be available to us on acceptable terms, or at all. To the extent that we raise additional capital through the sale of equity or debt, the terms of these securities may restrict our ability to operate. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights. If we are unable to raise capital when needed or on attractive terms, we could be forced to delay, reduce or altogether cease our research and development programs or future commercialization efforts.

 

Convertible Debt

 

As of September 30, 2019, we had $80.5 million of convertible notes outstanding, consisting of the 6.75% senior secured loan due 2020, or the Deerfield Convertible Note, in the principal amount of $6.8 million and the 5.50% Senior Convertible Notes due 2021, or the 2021 Notes, in the aggregate principal amount of $73.7 million.

 

Deerfield Facility Agreement

 

In June 2014, we entered into the $60.0 million multi-tranche credit facility, or the Deerfield Facility Agreement, with Deerfield Private Design Fund III, LP, or Deerfield. At the time we entered into the Deerfield Facility Agreement, we borrowed the first tranche, which consisted of a $15.0 million term note and the $10.0 million convertible note. We used approximately $18.6 million of the net proceeds from the offering of the 2021 Notes to repay in full the $15.0 million original principal amount on the term note issued under the Deerfield Facility Agreement plus all accrued but unpaid interest on the term note, a make whole interest payment on the term note and a prepayment premium on the term note. Deerfield is no longer obligated to provide us any additional disbursements under the Deerfield Facility Agreement. 

 

The Deerfield Convertible Note originally bore interest at 9.75% per annum, but was subsequently reduced to 6.75%. Interest accrued on the outstanding balance under the Deerfield Convertible Note is due quarterly in arrears. We originally had to repay one-third of the outstanding principal amount of the Deerfield Convertible Note on the fourth and fifth anniversaries of the Deerfield Facility Agreement (June 2018 and June 2019). In June 2018, Deerfield agreed to convert the $3,333,333 of the principal amount then due, plus $168,288 of accrued interest, into 598,568 shares of our common stock. In September 2019, we entered into an amendment with Deerfield in order to (i) reduce the interest rate applicable under the Deerfield Facility Agreement from 9.75% to 6.75%, (ii) provide for “payment in kind” of interest on the Loans (as defined in the Deerfield Facility Agreement), and (iii) defer the Loan payments due pursuant to the Deerfield Facility Agreement until June 1, 2020. We are also obligated to repay principal in the amount of $3,333,333 plus any capitalized interest to date on February 14, 2020. Prepayment of the outstanding balance is not allowed without written consent of Deerfield.

 

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Pursuant to the Deerfield Facility Agreement, we issued to Deerfield 1,923,077 shares of our Series D redeemable convertible preferred stock, or Series D Preferred, as consideration for the loans provided to us thereunder. Upon closing of our IPO, these shares of Series D Preferred reclassified into 256,410 shares of our common stock.

 

We also issued to Deerfield a warrant to purchase 14,423,076 shares of our Series D Preferred at an initial exercise price of $0.78 per share, or the Deerfield Warrant. Upon closing of our IPO, this warrant converted into a warrant exercisable for 1,923,077 shares of our common stock at an exercise price of $5.85 per share.

 

Pursuant to the Deerfield Facility Agreement, we may not enter into specified transactions, including a debt financing in the aggregate value of $750,000 or more, other than permitted indebtedness under the Deerfield Facility Agreement, a merger, an asset sale or any other change of control transaction or any joint venture, partnership or other profit-sharing arrangement, without the prior approval of Deerfield. Additionally, if we were to enter into a major transaction, including a merger, consolidation, sale of substantially all of our assets or other change of control transaction, Deerfield would have the ability to demand that prior to consummation of such transaction we repay all outstanding principal and accrued interest of the Deerfield Convertible Note. Deerfield has the right to demand that we redeem the Deerfield Warrant for a cash amount equal to the Black-Scholes value of a portion of the warrant upon the occurrence of specified events, including a merger, an asset sale or any other change of control transaction.

 

The Deerfield Facility Agreement also includes high yield discount obligation protections that went into effect in June 2019. Going forward, if at any interest payment date our outstanding indebtedness under the Deerfield Facility Agreement would qualify as an "applicable high yield discount obligation" under the Internal Revenue Code of 1986, as amended, or the Code, then we are obligated to prepay in cash on each such date the amount necessary to avoid such classification.

 

2021 Notes

 

In February 2016, we issued the 2021 Notes in aggregate principal amount of $86.3 million. The 2021 Notes were originally issued to Cowen and RBCCM as representatives of the several initial purchasers, who subsequently resold the 2021 Notes to qualified institutional buyers in reliance on the exemption from registration provided by Rule 144A under the Securities Act.  

 

The 2021 Notes were issued pursuant to an indenture, dated as of February 9, 2016, or the indenture, between the Company and U.S. Bank National Association, as trustee. Interest on the 2021 Notes is payable semi-annually in cash in arrears on February 1 and August 1 of each year, beginning on August 1, 2016, at a rate of 5.50% per year. The 2021 Notes mature on February 1, 2021 unless earlier converted or repurchased.  

 

The 2021 Notes are not redeemable prior to the maturity date, and no sinking fund is provided for the 2021 Notes. The 2021 Notes are convertible at an initial conversion rate of 58.4454 shares of our common stock per $1,000 principal amount of the 2021 Notes, subject to adjustment under the indenture, which is equal to an initial conversion price of approximately $17.11 per share of our common stock. Upon conversion, the 2021 Notes will be settled in shares of our common stock, together with a cash payment in lieu of delivering any fractional shares. The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, following certain corporate events that occur prior to the maturity date, we will increase the conversion rate for a holder who elects to convert its 2021 Notes in connection with such a corporate event in certain circumstances. These notes are not considered participating securities.

 

If we undergo a "fundamental change" (as defined in the indenture), holders may require that we repurchase for cash all or any portion of their 2021 Notes at a fundamental change repurchase price equal to 100% of the principal amount of the 2021 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

 

Holders who convert on or after the date that is one year after the last date of original issuance of the 2021 Notes may also be entitled to receive, under certain circumstances, an interest make-whole payment payable in shares of our common stock.

 

The indenture includes customary terms and covenants, including certain events of default after which the 2021 Notes may be due and payable immediately.

 

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2021 Note Exchange

 

2021 Note Exchange Effected in October 2018

 

In October 2018, we entered into an exchange agreement, or the October 2018 Exchange Agreement, with Deerfield and Deerfield Special Situations Fund, L.P. Under the October 2018 Exchange Agreement, Deerfield and Deerfield Special Situations Fund, L.P. exchanged an aggregate of $9,577,000 principal amount of our 2021 Notes for an aggregate of 9,577 shares of our Series A Convertible Preferred Stock, par value $0.0001, or the Series A Preferred Stock.

 

As a condition to closing of the October 2018 Exchange Agreement, we filed a Certificate of Designation of Preferences, Rights and Limitations of Series A Convertible Preferred Stock, or the Series A Certificate of Designation, with the Secretary of State of the State Delaware, setting forth the preferences, rights and limitations of the Series A Preferred Stock.

 

Each share of Series A Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of our common stock at a price equal to $3.00 per share (subject to adjustment to reflect stock splits and similar events). Immediately following the exchange under the October 2018 Exchange Agreement, an aggregate of 3,192,334 shares of common stock were issuable upon conversion of the Series A Preferred Stock. The Series A Preferred Stock is convertible at any time at the option of the holders thereof, provided that a holder of Series A Preferred Stock is prohibited from converting shares of Series A Preferred Stock into shares of common stock if, as a result of such conversion, such holder (together with certain affiliates and “group” members) would beneficially own more than 4.985% of the total number of shares of common stock then issued and outstanding. The Series A Preferred Stock is not redeemable. In the event of the our liquidation, dissolution or winding up, the holders of Series A Preferred Stock will receive an amount equal to $0.0001 per share, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of our assets with holders of common stock on an as-converted basis. With respect to rights upon liquidation, the Series A Preferred Stock ranks senior to the common stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving our organizational documents that materially and adversely affect the holders of Series A Preferred Stock), the Series A Preferred Stock does not have voting rights. The Series A Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that holders of Series A Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series A Certificate of Designation also provides for partial liquidated damages in the event that we fail to timely convert shares of Series A Preferred Stock into common stock in accordance with the Series A Certificate of Designation.

 

As of September 30, 2019, 6,240 shares of Series A Preferred Stock have been converted into 2,080,000 shares of common stock.

 

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2021 Note Exchange Effected in September 2019

 

In September 2019, we entered into an September 2019 Exchange Agreement with Deerfield and Deerfield Special Situations Fund, L.P. Under the September 2019 Exchange Agreement, we issued an aggregate of 1,499,894 shares of our common stock and an aggregate of 1,576 shares of our Series B-1 Convertible Preferred Stock, par value $0.0001 per share, or the Series B-1 Preferred Stock, (such shares of common stock and Series B-1 Preferred Stock, the Initial Exchange Shares), in exchange for the cancellation of an aggregate of $3,000,000 principal amount of the 2021 Notes. The September 2019 Exchange Agreement provides Deerfield and Deerfield Special Situations Fund, L.P. the option to exchange up to an additional aggregate of $27,000,000 principal amount of the 2021 Notes, or the Optional Exchange Principal Amount, for shares of common stock or shares of our Series B-2 Convertible Preferred Stock, par value $0.0001 per share, or the Series B-2 Preferred Stock, and, together with the Series B-1 Preferred Stock, the Series B Preferred Stock, subject to the terms and conditions set forth in the September 2019 Exchange Agreement, including limits as to the principal amount that can be exchanged prior to specified dates therein. If Deerfield or Deerfield Special Situations Fund, L.P. choose to exchange any portion of the Optional Exchange Principal Amount for shares of Series B-2 Preferred Stock, such exchange will be effected at an exchange price of $1,000 per share. If Deerfield or Deerfield Special Situations Fund, L.P. choose to exchange any portion of the Optional Exchange Principal Amount for shares of common stock, such exchange will be effected at an exchange price equal to the greater of (i) $0.9494, which represents the last sale price of the common stock on the Nasdaq Global Market on September 3, 2019, or (ii) the average of the volume-weighted average price of the common stock on the Nasdaq Global Market on each of the 15 trading days immediately preceding such exchange.

 

As a condition to closing of the September 2019 Exchange Agreement, we filed a Certificate of Designation of Preferences, Rights and Limitations of Series B-1 Convertible Preferred Stock, or the Series B-1 Certificate of Designation, and a Certificate of Designation of Preferences, Rights and Limitations of Series B-2 Convertible Preferred Stock, or the Series B-2 Certificate of Designation, with the Secretary of State of the State Delaware, setting forth the preferences, rights and limitations of the Series B-1 Preferred Stock and the Series B-2 Preferred Stock, respectively. 

 

Each share of Series B-1 Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a per share price equal to $0.9494 per share (subject to adjustment to reflect stock splits and similar events). There was an aggregate of 1,659,996 shares of common stock issuable upon conversion of the Series B-1 Preferred Stock (without giving effect to the limitation on conversion described below). Each share of Series B-2 Preferred Stock has an aggregate stated value of $1,000 and is convertible into shares of common stock at a per share price equal to the greater of (i) $0.9494 (subject to adjustment to reflect stock splits and similar events), or (ii) the average of the volume-weighted average prices of the common stock on the Nasdaq Global Market on each of the 15 trading days immediately preceding such exchange. Immediately following the exchange under the September 2019 Exchange Agreement and as of September 30, 2019, there was an aggregate of 28,439,015 shares of Common Stock issuable (i) in exchange of the Optional Exchange Principal Amount, or (ii) upon conversion of the Series B-2 Preferred Stock issuable in exchange of the Optional Exchange Principal Amount (in each case without giving effect to the limitation on conversion described below).

 

The Series B Preferred Stock is convertible at any time at the option of Deerfield or Deerfield Special Situations Fund, L.P.; provided that Deerfield and Deerfield Special Situations Fund, L.P. are prohibited from converting shares of Series B Preferred Stock into shares of common stock if, as a result of such conversion, such holders (together with certain affiliates and “group” members of such holders) would beneficially own more than 4.985% of the total number of shares of common stock then issued and outstanding. The Series B Preferred Stock is not redeemable. In the event of the Company’s liquidation, dissolution or winding up, Deerfield and Deerfield Special Situations Fund, L.P. will receive an amount equal to $0.0001 per share, plus any declared but unpaid dividends, and thereafter will share ratably in any distribution of our assets with holders of common stock and with the holders of any shares of any other class or series of capital stock of us entitled to share in such remaining assets of us (including our Series A Preferred Stock on an as-converted basis. With respect to rights upon liquidation, the Series B Preferred Stock ranks senior to the common stock, on parity with the Series A Preferred Stock and junior to existing and future indebtedness. Except as otherwise required by law (or with respect to approval of certain actions involving our organizational documents that materially and adversely affect the holders of Series B Preferred Stock), the Series B Preferred Stock does not have voting rights. The Series B Preferred Stock is not subject to any price-based anti-dilution protections and does not provide for any accruing dividends, but provides that holders of Series B Preferred Stock will participate in any dividends on the common stock on an as-converted basis (without giving effect to the limitation on conversion described above). The Series B-1 Certificate of Designation and the Series B-2 Certificate of Designation also provide for partial liquidated damages in the event that the Company fails to timely convert shares of Series B-1 Preferred Stock or Series B-2 Preferred Stock, respectively, into common stock in accordance with the applicable Certificate of Designation.

 

As of September 30, 2019, 787 shares of Series B-1 Preferred Stock have been converted into 828,945 shares of common stock.

  

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Cash Flows

 

The following table summarizes our cash flows for the nine months ended September 30, 2019 and 2018 (in thousands):

 

   

Nine months ended September 30,

   

2019

 

2018

Net cash used in operating activities

  $ (20,639   $ (39,205

Net cash provided by investing activities

     3,239        25,368  

Net cash provided by financing activities

     5,289        4,754  

Net decrease in cash, cash equivalents and restricted cash

   (12,111 )   (9,083 )

 

Operating Activities

 

For the nine months ended September 30, 2019, net cash used in operating activities of $20.6 million consisted of a net loss of $18.5 million, primarily attributable to our spending on research and development programs, partially offset by revenue received under the KP415/484 License Agreement, and $6.2 million in changes in working capital; partially offset by $4.1 million in adjustments for non-cash items. The adjustments for non-cash items primarily consisted of stock-based compensation expense of $3.7 million, non-cash interest expense of $1.0 million, amortization of debt issuance costs and debt discount of $1.0 million and $0.2 million related to depreciation, amortization and other items; partially offset by non-cash income related to the change in the fair value of our derivative and warrant liabilities of $1.8 million. The changes in working capital consisted of $1.5 million related to a change in accounts and other receivables, $6.1 million related to a change in accounts payable and accrued expenses, $1.6 million related to operating lease right-of-use assets and $0.8 million related to a change in other liabilities; partially offset by $1.4 million related to a change in prepaid expenses and other assets and $2.3 million related to operating lease liabilities.

 

For the nine months ended September 30, 2018, net cash used in operating activities of $39.2 million consisted of a net loss of $51.3 million, primarily attributable to our spending on research and development programs, partially offset by $7.4 million in adjustments for non-cash items and $4.7 million in changes in working capital. The adjustments for non-cash items primarily consisted of stock-based compensation expense of $5.2 million, non-cash interest expense of $1.1 million, amortization of debt issuance costs and debt discount of $1.1 million and $0.3 million related to depreciation, amortization and other items; partially offset by non-cash income related to the change in the fair value of our derivative and warrant liabilities of $0.3 million. The changes in working capital consisted of $5.8 million related to an increase in accounts payable and accrued expenses, partially offset by a change of $0.1 million related to accounts and other receivables, $1.0 million related to an increase in prepaid expenses and other assets and a change of $0.1 million related to a decrease in other liabilities.

 

Investing Activities

 

For the nine months ended September 30, 2019, net cash provided by investing activities was $3.2 million, which was primarily attributable to maturities of marketable securities.

 

For the nine months ended September 30, 2018, net cash provided by investing activities was $25.4 million, which was primarily attributable to maturities and sales of marketable securities.

 

Financing Activities

 

For the nine months ended September 30, 2019, net cash provided by financing activities was $5.3 million, which was primarily attributable to proceeds from sales of our common stock under the Purchase Agreement of $5.4 million; partially offset by repayment of principal on finance lease liabilities of $0.2 million.

 

For the nine months ended September 30, 2018, net cash provided by financing activities was $4.8 million. This consisted of net proceeds from the issuance of common stock under the First ATM agreement of $4.8 million and proceeds from the exercise of common stock options of $0.1 million, partially offset by repayment of $0.1 million of obligations under capital lease arrangements.

  

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Future Funding Requirements

 

We anticipate that we will need substantial additional funding in connection with our continuing operations. Based upon our current operating plan and existing cash resources as of September 30, 2019, we believe our existing resources are sufficient to fund operating expense and capital investment requirements into, but not through, the second quarter of 2020.

 

Potential near-term sources of additional funding include:

 

 

sales of common stock under the Second ATM Agreement;

 

sales of common stock under the Purchase Agreement;

 

any revenues generated under the APADAZ License Agreement; and

 

any out-of-pocket third-party research and development cost reimbursements, consulting services revenue or short-term milestone payments generated under the KP415/484 License Agreement.

 

We cannot guarantee that we will be able to generate sufficient proceeds from any of these potential sources to fund our operating expenses. For instance, pursuant to the terms of the Purchase Agreement, stockholder approval may be required to access a portion of the amounts available under the Purchase Agreement. Accordingly, we cannot guarantee that we will be able to sell the full $15.0 million subject to the terms of the Purchase Agreement.

 

To date, we have only generated revenue from the non-refundable upfront payment and consulting services under the KP415/484 License Agreement, and, as of September 30, 2019, we have a net working capital (current assets less current liabilities) deficit of $1.7 million. We do not know when, or if, we will generate any additional revenue. We expect that our only source of revenues will be through payments arising from our license agreements with KVK and Commave, and/or through any other future arrangements related to one of our product candidates. While we have entered into the APADAZ License Agreement to commercialize APADAZ in the United States, and entered into the KP415/484 License Agreement to develop, manufacture and commercialize KP415 and KP484, we cannot guarantee that this, or any strategy we adopt in the future, will be successful. We also expect to continue to incur additional costs associated with operating as a public company. In addition, we expect to incur significant commercialization expenses for product sales, marketing, manufacturing and distribution of any of our product candidates that achieve regulatory approval.

 

Our unaudited condensed financial statements for the quarter ended September 30, 2019, includes an explanatory paragraph, within Note A, stating that our recurring losses, negative operating cash flows and stockholders' deficit raise substantial doubt about our ability to continue as a going concern. We expect that our only source of revenues will be through payments arising from our license agreements with KVK and Commave, and/or through any other future arrangements related to one of our other product candidates. Accordingly, our ability to continue as a going concern will require us to obtain additional financing to fund our operations. The perception of our inability to continue as a going concern may make it more difficult for us to obtain financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees. Adequate additional financing may not be available to us on acceptable terms, or at all. To the extent that we raise additional capital through the sale of equity or debt, the terms of these securities may restrict our ability to operate. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights. If we are unable to raise capital when needed or on attractive terms, we could be forced to delay, reduce or altogether cease our research and development programs or future commercialization efforts.

 

We have based our estimates of our cash needs and cash runway on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect and we cannot guarantee that we will be able to generate sufficient proceeds from our license agreements with KVK and Commave, sales under our Purchase Agreement or Second ATM Agreement or other funding transactions to fund our operating expenses. To meet any additional cash requirements, we may seek to sell additional equity or convertible securities that may result in dilution to our stockholders, issue additional debt or seek other third-party funding, including potential strategic transactions, such as licensing or collaboration arrangements. Because of the numerous risks and uncertainties associated with the development and commercialization of product candidates and products, we are unable to estimate the amounts of increased capital outlays and operating expenditures necessary to complete the commercialization and development of our partnered product or product candidates, should they obtain regulatory approval.

 

We have filed a shelf registration statements on Form S-3 with the SEC. Based on the market value of our outstanding common stock held by non-affiliates as of March 1, 2019, the date we filed our Annual Report on Form 10-K for the year ended December 31, 2018, in order to issue securities under our Current Registration Statement or our Replacement Registration Statement, once effective, we must rely on Instruction I.B.6. of Form S-3, which imposes a limitation on the maximum amount of securities that we may sell pursuant to the registration statements during any twelve-month period. At the time we sell securities pursuant to the applicable registration statement, the amount of securities to be sold plus the amount of any securities we have sold during the prior twelve months in reliance on Instruction I.B.6. may not exceed one-third of the aggregate market value of our outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale, as computed in accordance with Instruction I.B.6. This calculation was updated immediately after we filed our Annual Report on Form 10-K for the year ended December 31, 2018 on March 1, 2019. As of that date, the amount of securities we are be able to sell under a registration statement on Form S-3 during a 12-month period was approximately $18.5 million, of which prospectus supplements were filed to register (i) approximately $15.3 million for sales under the Purchase Agreement, and (ii) approximately $3.2 million for sales under our Second ATM Agreement. Based on this calculation, we expect that we will be unable to sell additional securities beyond those amounts pursuant to the Current Registration Statement or the Replacement Registration Statement, once effective, for a period of twelve months, unless and until the market value of our outstanding common stock held by non-affiliates increases significantly. In addition, under the terms of the Purchase Agreement, stockholder approval may be required to access a portion of the amounts available under the Purchase Agreement.

 

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Off-Balance Sheet Arrangements

 

During the periods presented, we did not have, nor do we currently have, any off-balance sheet arrangements as defined under SEC rules.

 

Critical Accounting Policies and Significant Judgements and Estimates

 

This management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our financial statements, as well as the reported revenues and expenses during the reported periods. We evaluate these estimates and judgements on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgements about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Our critical accounting policies have not changed materially from those described in Note B of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on March 1, 2019.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

Item 4.

Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

 

Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2019. Based on the evaluation of our disclosure controls and procedures as of September 30, 2019, our chief executive officer and our chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control Over Financial Reporting

 

There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during our fiscal quarter ended September 30, 2019 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

From time to time, we may be involved in routine legal proceedings, as well as demands, claims and threatened litigation, which arise in the normal course of our business. We believe there is no litigation pending that would reasonably be expected to, individually or in the aggregate, have a material adverse effect on our results of operations or financial condition.

 

Item 1A.

Risk Factors

 

You should carefully consider all the risk factors and uncertainties described below, in addition to other information contained in this Quarterly Report on Form 10-Q, including the section of this report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our condensed financial statements and related notes, before investing in our common stock. If any of the following risks materialize, our business, financial condition and results of operations could be seriously harmed. This Quarterly Report on Form 10-Q also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements because of factors that are described below and elsewhere in this Quarterly Report on Form 10-Q.

  

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Risks Related to Our Financial Position and Capital Needs 

 

We will need substantial additional funding to pursue our business objectives. If we are unable to raise capital when needed, we could be forced to delay, reduce or altogether cease our prodrug development programs or commercialization efforts or cease operations altogether.

 

Based on our current operating plan, our existing resources are expected to be sufficient to fund our operating expense and capital investment requirements into, but not through, the second quarter of 2020. We do not currently have sufficient funds to finance our continuing operations beyond the short-term or to substantially advance our product candidates further into clinical development. We expect that our only source of revenues will be through payments arising from our license agreements with KVK and Commave, and/or through any other future arrangements related to one of our other product candidates. Accordingly, our ability to continue as a going concern will require us to obtain, in the short term, additional financing to fund our operations. In order to substantially advance development of our product candidates, we will need to obtain additional funding in connection with our continuing operations from one or more equity offerings, including pursuant to our Purchase Agreement with Lincoln Park, the Second ATM Agreement with RBCCM, debt financings, the APADAZ License Agreement, the KP415/484 License Agreement or other third-party funding, including potential strategic alliances and licensing or collaboration arrangements, and we cannot guarantee that we will be able to generate sufficient proceeds from sales under the Purchase Agreement, the Second ATM Agreement, the APADAZ License Agreement or the KP415/484 License Agreement, or be successful in completing other transactions, that will fund our operating expenses. If we are delayed in obtaining additional funding or are unable to complete a strategic transaction, we may discontinue our development activities on our product candidates or discontinue our operations. Even if we are able to fund continued development and any of our product candidates are approved, we expect that we will need to complete a strategic transaction or raise substantial additional funding through public or private debt or equity securities to successfully commercialize any product candidate. Our future capital requirements will depend on many factors, including:

 

 

the progress and results of our preclinical studies, clinical trials, chemistry, manufacturing and controls, or CMC, and other product development and commercialization activities;

 

 

 

 

the scope, progress, results and costs of preclinical development, laboratory testing and clinical trials for our product candidates;

 

 

 

 

the ability to obtain differentiating claims in the labels for our product candidates;

 

 

 

 

the number and development requirements of other product candidates that we may pursue;

 

 

 

 

the costs, timing and outcome of regulatory review of our product candidates;

 

 

 

 

the efforts necessary to institute post-approval regulatory compliance requirements;

 

 

 

 

the costs and timing of future commercialization activities, including product manufacturing, marketing, sales and distribution, for any of our product candidates for which we receive marketing approval;

 

 

 

 

the revenue, if any, received from commercial sales of APADAZ under our APADAZ License Agreement, or any product candidate subject to the terms of the KP415/484 License agreement or sales of our other product candidates for which we receive marketing approval, which may be affected by market conditions, including obtaining coverage and adequate reimbursement of APADAZ or our product candidates from third-party payors, including government programs and managed care organizations, and competition within the therapeutic class to which APADAZ or our product candidates are assigned; 

     
  our success in developing and commercializing our ADHD product candidates in accordance with the terms of the KP415/484 License Agreement agreement;

 

 

 

 

the costs and timing of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending any intellectual property-related claims; and

 

 

 

 

the extent to which we acquire or in-license other product candidates and technologies.

 

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The auditor's opinion on our audited financial statements for the fiscal year ended December 31, 2018, included in our annual report on Form 10-K, contained an explanatory paragraph relating to our ability to continue as a going concern.

 

The auditor's opinion on our audited financial statements for the year ended December 31, 2018 included an explanatory paragraph stating that our recurring losses from operations, stockholders' deficit and negative operating cash flows raise substantial doubt about our ability to continue as a going concern. While we believe that we will be able to raise the capital we need to continue our operations, there can be no assurances that we will be successful in these efforts or will be able to resolve our liquidity issues or eliminate our operating losses. If we are unable to obtain sufficient funding, we would need to significantly reduce our operating plans and curtail some or all of our product development, commercialization and strategic plans. Accordingly, our business, prospects, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our audited financial statements, and it is likely that investors will lose all or a part of their investment. If we seek additional financing to fund our business activities in the future and there remains substantial doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding on commercially reasonable terms or at all.

 

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We have incurred significant operating losses since our inception. We expect to incur operating losses over the next several years and may never achieve or maintain profitability.

 

We have had negative operating cash flows since our inception and, as of September 30, 2019, had an accumulated deficit of $239.7 million and a net working capital (current assets less current liabilities) deficit of $1.7 million. Our negative cash flows from operations for the nine months ended September 30, 2019 and 2018, were $20.6 million and $39.2 million, respectively. We have financed our operations through September 30, 2019 with funds raised in private placements of redeemable convertible preferred stock, in  the issuance of convertible promissory notes and term debt, our initial public offering and other public and private offerings of our common stock, as well as through revenue received under the KP415/484 License Agreement. In February 2019, we also entered into the Purchase Agreement with Lincoln Park, which provides that, upon the terms and subject to the conditions and limitations set forth therein, we may sell to Lincoln Park up to $15.0 million of shares of our common stock, from time to time over the 36-month term of the Purchase Agreement, and upon execution of the Purchase Agreement we issued an additional 120,200 shares of our common stock to Lincoln Park as commitment shares in accordance with the closing conditions contained within the Purchase Agreement. Concurrently with entering into the Purchase Agreement, we also entered into a Registration Rights Agreement with Lincoln Park, pursuant to which we agreed to register the sale of the shares of our common stock that have been and may be issued to Lincoln Park under the Purchase Agreement pursuant to our existing shelf registration statement on Form S-3 or a new registration statement. As of September 30, 2019, we have sold 3,401,271 shares of our common stock to Lincoln Park under the Purchase Agreement for approximately $5.4 million in gross proceeds.

 

Our negative cash flows from operations, accumulated deficit and net working capital deficit raise substantial doubt about our ability to continue as a going concern. The perception of our inability to continue as a going concern may make it more difficult for us to obtain financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees. We have devoted substantially all of our financial resources and efforts to research and development, including preclinical studies and clinical trials. We are in various stages of development of our product candidates, and we have only completed development of, and received regulatory approval for, one product, APADAZ. We expect to continue to incur significant expenses and operating losses over the next several years and our net losses may fluctuate significantly from quarter to quarter and year to year as we:

 

 

continue our ongoing preclinical studies, clinical trials and our product development activities for our pipeline of product candidates;

     

 

seek regulatory approvals for product candidates that successfully complete clinical trials;

     

 

continue research and preclinical development and initiate clinical trials of our product candidates;

     

 

seek to discover and develop additional product candidates either internally or in partnership with other pharmaceutical companies;

     

 

adapt our regulatory compliance efforts to incorporate requirements applicable to marketed products;

     

 

maintain, expand and protect our intellectual property portfolio;

     

 

incur additional legal, accounting and other expenses in operating as a public company; and

     

 

add operational systems and personnel, if needed, to support any future commercialization efforts.

 

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To become and remain profitable, we must succeed in developing and eventually commercializing prodrugs that generate significant revenue. This will require us to be successful in a range of challenging activities, including completing preclinical studies and clinical trials and obtaining regulatory approval of our product candidates, and manufacturing, marketing and selling, whether ourselves or through a license with a third party, any of our product candidates for which we may obtain regulatory approval, as well as discovering and developing additional product candidates. We are in various stages of these activities for our product candidates, and we cannot guarantee that any strategy we adopt will be successful. For instance, in October 2018, we entered into the APADAZ License Agreement with KVK pursuant to which we granted an exclusive license to KVK to commercialize APADAZ in the United States. We cannot guarantee that KVK will be able to successfully commercialize APADAZ or that we will ever receive any payments under the APADAZ License Agreement from commercial sales of APADAZ. In addition, in September 2019, we entered into the KP415/484 License Agreement with Commave pursuant to which we granted an exclusive, worldwide license to Commave to develop, manufacture and commercialize KP415 and KP484 worldwide. Even if approved, we cannot guarantee that Commave will be able to successfully develop, manufacture or commercialize KP415 or KP484 or that we will ever receive any future payments under the KP415/484 License Agreement. We may never succeed in commercialization activities and, even if we do, may never generate revenue that is significant enough to achieve profitability.

 

Because of the numerous risks and uncertainties associated with prodrug development, we are unable to accurately predict the timing or amount of expenses or when, or if, we will be able to achieve profitability. If we are required by regulatory authorities to perform studies in addition to those currently expected, or if there are any delays in the initiation and completion of our clinical trials or the development of any of our product candidates, our expenses could increase.

 

Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would depress our value and could impair our ability to raise capital, expand our business, maintain our research and development efforts, obtain product approvals, diversify our product offerings or continue our operations. A decline in our value could also cause you to lose all or part of your investment.

 

Identifying potential product candidates and conducting preclinical studies and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may not generate the necessary data or results required to obtain regulatory approval for our product candidates or claims necessary to make such candidates profitable and achieve product sales. In addition, APADAZ or our product candidates, if approved, may not achieve commercial success. Our commercial revenue, if any, will be derived from sales of prodrug products. We cannot guarantee that KVK will be able to successfully commercialize APADAZ, that Commave will be able to successfully commercialize any product candidates subject to the KP415/484 License Agreement, even if approved, or that we will ever receive any payments under the APADAZ License Agreement from commercial sales of APADAZ or any future payments under the KP415/484 License Agreement. Accordingly, we will need to continue to rely on additional financing to achieve our business objectives. Adequate additional financing may not be available to us on acceptable terms, or at all. To the extent that we raise additional capital through the sale of equity or debt securities, the terms of these securities or this debt may restrict our ability to operate. In June 2014, we entered into the Deerfield Facility Agreement with Deerfield. The Deerfield Facility Agreement includes, and any future debt financing and equity financing, if available, may involve agreements that include, covenants limiting and restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, entering into profit-sharing or other arrangements or declaring dividends. The Deerfield Facility Agreement also includes high yield discount obligation protections that went into effect in June 2019. Going forward, if at any interest payment date our outstanding indebtedness under the Deerfield facility would qualify as an "applicable high yield discount obligation" under the Code, then we are obligated to prepay in cash on each such date the amount necessary to avoid such classification. Additionally, in February 2016, we issued the 2021 Notes. We are required to make periodic interest payments to the holders of the 2021 Notes and to make payments of principal upon maturity. In this regard, if holders of the 2021 Notes do not convert their 2021 Notes prior to the maturity date, we will be required to repay the principal amount of all then outstanding 2021 Notes plus any accrued and unpaid interest. We may also be required to repurchase the 2021 Notes for cash upon the occurrence of a change of control or certain other fundamental changes involving us. If our capital resources are insufficient to satisfy our debt service obligations, we will be required to seek to sell additional equity or debt or to obtain debt financing. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. In addition, we may seek additional capital due to favorable market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. If we are unable to raise capital when needed or on attractive terms, we could be forced to delay, reduce or altogether cease our research and development programs or future commercialization efforts.

 

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We may be unable to issue securities under our shelf registration statement, which may have an adverse effect on our liquidity.

 

We have filed a shelf registration statements on Form S-3 with the SEC. Based on the market value of our outstanding common stock held by non-affiliates as of March 1, 2019, the date we filed our Annual Report on Form 10-K for the year ended December 31, 2018, in order to issue securities under our Current Registration Statement or our Replacement Registration Statement, once effective, we must rely on Instruction I.B.6. of Form S-3, which imposes a limitation on the maximum amount of securities that we may sell pursuant to the registration statements during any twelve-month period. At the time we sell securities pursuant to the applicable registration statement, the amount of securities to be sold plus the amount of any securities we have sold during the prior twelve months in reliance on Instruction I.B.6. may not exceed one-third of the aggregate market value of our outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale, as computed in accordance with Instruction I.B.6. This calculation was updated immediately after we filed our Annual Report on Form 10-K for the year ended December 31, 2018 on March 1, 2019. As of that date, the amount of securities we are be able to sell under a registration statement on Form S-3 during a 12-month period was approximately $18.5 million, of which prospectus supplements were filed to register (i) approximately $15.3 million for sales under the Purchase Agreement, and (ii) approximately $3.2 million for sales under our Second ATM Agreement. Based on this calculation, we expect that we will be unable to sell additional securities beyond those amounts pursuant to the Current Registration Statement or the Replacement Registration Statement, once effective, for a period of twelve months, unless and until the market value of our outstanding common stock held by non-affiliates increases significantly. In addition, under the terms of the Purchase Agreement, stockholder approval may be required to access a portion of the amounts available under the Purchase Agreement. If we cannot sell securities under our Current Registration Statement or the Replacement Registration Statement, once effective, we may be required to utilize more costly and time-consuming means of accessing the capital markets, which could materially adversely affect our liquidity and cash position.

 

Our operating history may make it difficult for you to evaluate the success of our business to date and to assess our future viability.

 

We commenced active operations in 2006, and our operations to date have been largely focused on raising capital, identifying potential product candidates, broadening our expertise in the development of our prodrugs, undertaking preclinical studies and conducting clinical trials. To date, we have only one product approved by the FDA, APADAZ for the short-term (no more than 14 days) management of acute pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate. We have not yet demonstrated an ability to manufacture a prodrug on a commercial scale, or arrange for a third party to do so, or conduct sales and marketing activities necessary for successful commercialization. Further, we cannot guarantee that KVK will be able to successfully commercialize APADAZ, that Commave will be able to successfully commercialize any product candidates subject to the KP415/484 License Agreement, if approved, or that we will ever receive any payments under the APADAZ License Agreement or the KP415/484 License Agreement from commercial sales of APADAZ or any other approved product candidates, if any. Consequently, any predictions you make about our future success or viability may not be as accurate as they could be if we had a longer operating history.

 

We may encounter unforeseen expenses, difficulties, complications, delays and other known or unknown factors in achieving our business objectives. We will need to transition at some point from a company with a research and development focus to a company capable of supporting commercial activities. We may not be successful in such a transition.

 

We expect our financial condition and operating results to continue to fluctuate significantly from quarter to quarter and year to year due to a variety of factors, many of which are beyond our control. Accordingly, you should not rely upon the results of any quarterly or annual periods as indications of future operating performance.

 

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Risks Related to the Development of Our Product Candidates

 

Our research and development activities are focused on discovering and developing proprietary prodrugs, and we are taking an innovative approach to discovering and developing prodrugs, which may never lead to marketable prodrug products.

 

A key element of our strategy is to use our proprietary LAT technology to build a pipeline of prodrugs and progress product candidates based on these prodrugs through clinical development for the treatment of a variety of diseases and conditions. The scientific discoveries that form the basis for our efforts to discover and develop prodrugs are relatively new. As our scientific efforts are primarily focused on discovering novel prodrugs with new molecular structures, the evidence to support the feasibility of developing product candidates based on these discoveries is both preliminary and limited. Although our research and development efforts to date have resulted in a pipeline of prodrug product candidates, we may not be able to develop those product candidates into prodrugs that are bioequivalent, safe and effective and that have commercially significant improvements over already approved drugs. Even if we are successful in continuing to build our pipeline, the potential product candidates that we identify may not be suitable for clinical development, for reasons including being shown to have harmful side effects, a lack of efficacy, or other characteristics that indicate that they are unlikely to be prodrugs that will receive marketing approval and achieve market acceptance. For instance, in June 2016, we received a Complete Response Letter, or CRL, from the FDA for the APADAZ new drug application, or NDA. Following a Formal Dispute Resolution Request, or FDRR, process and detailed discussions with the FDA, we responded to the CRL by submitting an amended NDA for APADAZ. In February 2018, we announced that the FDA approved the NDA for APADAZ. If APADAZ is not successfully commercialized under our License Agreement and we do not successfully develop and commercialize our product candidates based upon our proprietary LAT technology, we will not be able to obtain product revenue in future periods, which likely would result in significant harm to our financial position and adversely affect our stock price.

 

If we are not able to obtain required regulatory approvals for our product candidates, we will not be able to commercialize them and our ability to generate revenue or profits or to raise future capital could be limited.

 

The research, testing, manufacturing, labeling, packaging, storage, approval, sale, marketing, advertising and promotion, pricing, export, import and distribution of drug products are subject to extensive regulation by the FDA and other regulatory authorities in the United States and other countries, which regulations differ from country to country and change over time. We are not permitted to market any of our product candidates in the United States until we receive approval of an NDA from the FDA, or in any foreign countries until we receive the requisite approvals in such countries. In the United States, the FDA generally requires the completion of non-clinical testing and clinical trials of each drug to establish its safety and efficacy and extensive pharmaceutical development to ensure its quality and other factors before an NDA is approved. Regulatory authorities in other jurisdictions impose similar requirements. Of the large number of drugs in development, only a small percentage result in the submission of an NDA to the FDA and even fewer are approved for commercialization.

 

Even if regulatory approval is obtained, subsequent safety, efficacy, quality or other issues can result in a product approval being suspended or withdrawn. On February 23, 2018, we announced that the FDA approved the NDA for APADAZ for the short-term (no more than 14 days) management of acute pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate. Even with the regulatory approval of APADAZ by the FDA, we cannot guarantee that the FDA will approve any of our other product candidates for commercial sale. If our development efforts for our product candidates, including regulatory approval, are not successful for their planned indications or are delayed, or if adequate demand for our product candidates that are approved for marketing, if any, is not generated, our business will be harmed.

 

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The success of our product candidates will depend on the receipt and maintenance of regulatory approval and the issuance and maintenance of such approval is uncertain and subject to a number of risks, including the following:

 

 

the FDA or comparable foreign regulatory authorities, institutional review boards, or IRBs, or ethics committees may disagree with the design or conduct of our clinical trials;

     

 

the results of our clinical trials may not meet the level of statistical or clinical significance required by the FDA or other regulatory agencies for marketing approval or for us to receive approval for claims that are necessary for commercialization;

     

 

the dosing in a particular clinical trial may not be at an optimal level;

     

 

patients in our clinical trials may suffer adverse effects for reasons that may or may not be related to our product candidates;

     

 

the data collected from clinical trials may not be sufficient to support submissions to regulatory authorities or to obtain regulatory approval in the United States or elsewhere;

     

 

the FDA or comparable foreign regulatory authorities may fail to approve the manufacturing processes or facilities of third-party manufacturers with which we contract for clinical and commercial supplies or may later suspend or withdraw such approval;

     

 

the approval policies or regulations of the FDA or comparable foreign regulatory authorities may significantly change in a manner rendering our clinical data insufficient for approval; and 

     

 

even if we obtain marketing approval in one or more countries, future safety or other issues could result in the suspension or withdrawal of regulatory approval in such countries.

 

We have only limited experience in filing the applications necessary to gain regulatory approvals and have relied, and expect to continue to rely, on consultants and third-party contract research organizations, or CROs, with expertise in this area to assist us in this process. Securing FDA approval requires the submission of extensive non-clinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the FDA for each therapeutic indication to establish a product candidate's safety and efficacy for each indication and manufacturing quality. Additionally, we cannot guarantee that regulators will agree with our assessment of the results of the clinical trials we have conducted or that any future trials will be successful. For example, in May 2016, the Anesthetic and Analgesic Drug Products Advisory Committee and the Drug Safety and Risk Management Advisory Committee of the FDA voted 16 to 4 for the approval of APADAZ but voted 18 to 2 against inclusion of abuse-deterrent labeling for APADAZ. Additionally, in June 2016, we received a CRL from the FDA for the APADAZ NDA. Following a FDRR process and detailed discussions with the FDA, we responded to the CRL we received in June 2016 by submitting an amended NDA for APADAZ for the short-term (no more than 14 days) management of acute pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate. In February 2018, we announced that the FDA approved the NDA for APADAZ.

 

Any product candidates we develop may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use with respect to one or all intended indications.

 

The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon, among other things, the type, complexity and novelty of the product candidates involved, the jurisdiction in which regulatory approval is sought and the substantial discretion of the regulatory authorities. Changes in the regulatory approval policy during the development period, changes in or the enactment of additional statutes or regulations, or changes in regulatory review for a submitted product application may cause delays in the approval or rejection of an application or may result in future withdrawal of approval. Regulatory approval obtained in one jurisdiction does not necessarily mean that a product candidate will receive regulatory approval in all jurisdictions in which we may seek approval, but the failure to obtain approval in one jurisdiction may negatively impact our ability to seek approval in a different jurisdiction. Failure to obtain regulatory marketing approval of our product candidates in any indication will prevent us from commercializing those product candidates for that indication, and our ability to generate revenue will be impaired.

  

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We are early in our development efforts and have only one product which has completed development and obtained regulatory approval by the FDA, APADAZ. All our other active product candidates are in clinical or preclinical development. If commercialization of APADAZ or our product candidates is not successful, or we experience significant delays in commercialization, our business will be harmed.

 

We are early in our development efforts and have only one product that has completed development and been approved by the FDA, APADAZ. All of our other active product candidates are in clinical or preclinical development. We currently generate no commercial revenue from the sale of any prodrugs and we may never be able to successfully commercialize a prodrug product. For instance, while  we have entered into the APADAZ License Agreement with KVK pursuant to which we granted an exclusive license to KVK to commercialize APADAZ in the United States, we cannot guarantee that KVK will be able to successfully commercialize APADAZ or that we will ever receive any payments under the APADAZ License Agreement from commercial sales of APADAZ. In addition, we entered into the KP415/484 License Agreement with Commave pursuant to which we granted an exclusive, worldwide license to Commave to develop, manufacture and commercialize KP415 and KP484 worldwide. We cannot guarantee that Commave will be able to successfully develop, manufacture or commercialize KP415 or KP484 or that we will ever receive any future payments under the KP415/484 License Agreement. We have invested substantially all our efforts and financial resources in the development of our proprietary LAT technology, the identification of potential product candidates and the development of our product candidates. Our ability to generate revenue from APADAZ under the APADAZ License Agreement and generate revenue from our product candidates will depend heavily on their successful development and eventual commercialization. The success of APADAZ and our product candidates will depend on several factors, including:

 

 

successful completion of preclinical studies and requisite clinical trials;

     

 

successful completion and achievement of endpoints in our clinical trials;

     

 

demonstration that the risks involved with APADAZ and our product candidates are outweighed by the benefits;

     

 

successful development of our manufacturing processes for APADAZ under the APADAZ License Agreement and for sales of our product candidates, if approved, including entering into and maintaining arrangements with third-party manufacturers;