Arcutis Biotherapeutics, Inc. (ARQT) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Overview
We are a commercial-stage biopharmaceutical company focused on developing and commercializing treatments for dermatological diseases with high unmet medical needs. Our current portfolio is comprised of highly differentiated topical and systemic treatments with significant potential to treat immune-mediated dermatological diseases and conditions. We believe we have built the industry's leading platform for dermatologic product development and commercialization. Our strategy is to focus on validated biological targets, and to use our drug development platform and deep dermatology expertise to develop differentiated products that have the potential to address the major shortcomings of existing therapies in our targeted indications. We believe this strategy uniquely positions us to rapidly advance our goal of bridging the treatment innovation gap in dermatology, while maximizing our probability of technical success and financial resources.
We launched our lead product, ZORYVE® (roflumilast) cream 0.3% ("ZORYVE cream"), in August 2022 after obtaining our initial U.S. Food and Drug Administration ("FDA") approval for the treatment of plaque psoriasis, including psoriasis in the intertriginous areas (e.g. groin or axillae), in individuals 12 years of age or older. ZORYVE cream is approved for once-daily treatment of mild, moderate, and severe plaque psoriasis with no limitations on location or duration of use. In October 2023, we received FDA approval for an expanded indication in plaque psoriasis down to 6 years of age. We are currently working with the FDA to potentially further expand this indication in plaque psoriasis down to 2 years of age following the generation of additional clinical data. In April 2023, we had our first commercial launch outside of the United States following Health Canada approval of ZORYVE cream for the treatment of plaque psoriasis in individuals 12 years or age or older. ZORYVE cream is a once-daily topical formulation of roflumilast, a highly potent and selective phosphodiesterase-4 (“PDE4”) inhibitor. PDE4 is an established biological target in dermatology, with multiple PDE4 inhibitors approved by the FDA for the treatment of dermatological conditions.
We have made significant progress in driving access and coverage of ZORYVE cream since launch. Weekly prescriptions have continued to increase since launch, with approximately 165,000 prescriptions written as of February 16, 2024. We believe this growth is due to our ability to drive prescriber awareness and use, patient engagement and positive experience with ZORYVE cream, and our efforts to establish broad, high-quality access for ZORYVE cream. For example, we established access through three large pharmacy benefit managers in the United States within 12 months of launch. We estimate that more than 10,700 unique prescribers have prescribed ZORYVE cream since launch. We estimate that approximately one third of our prescriptions are currently refill prescriptions, and we experienced significant growth in refill prescriptions in the second half of 2023 following our early commercialization efforts and patient engagement. Market research points to an increasing preference among dermatologists to prescribe ZORYVE cream as a topical treatment of plaque psoriasis, and transitions from topical corticosteroids have been the largest source of new prescriptions for ZORYVE cream since launch. With respect to commercial payers, we have engaged multiple key insurers and estimate that insurance coverage for ZORYVE cream is available to approximately 132 million commercially covered lives in the United States. We anticipate that we will be able to obtain Medicare and Medicaid coverage for ZORYVE as early as 2024.
In December 2023, we received FDA approval for ZORYVE® (roflumilast) topical foam 0.3% ("ZORYVE foam") for the treatment of seborrheic dermatitis in individuals aged 9 years and older, with no limitation on severity, location, or duration of use. ZORYVE foam has been shown to provide rapid disease clearance and significant reduction in itch in clinical trials. In a pivotal Phase 3 study, 80% of individuals treated with ZORYVE foam achieved the primary efficacy endpoint of IGA Success, defined as an IGA score of “clear” or “almost clear” plus a 2-point improvement at Week 8 and just over 50% of individuals achieved an IGA score of clear at Week 8. In addition,
95
Table of Contents
Index to Financial Statements
individuals treated with ZORYVE foam reported reductions in itch from baseline within 48 hours of first application. ZORYVE foam is a once-daily steroid-free foam and, as a PDE4 inhibitor, is the first drug approved for the treatment of seborrheic dermatitis with a new mechanism of action in over two decades. ZORYVE foam became commercially available in late January 2024, and as of February 16, 2024, 7,000 prescriptions have been written since launch. Seborrheic dermatitis is estimated to occur in as many as 10 million people in the United States, and is associated with a substantial psychosocial burden for those suffering from the disease.
In addition to the approval of ZORYVE cream for plaque psoriasis and ZORYVE foam for seborrheic dermatitis (collectively, "ZORYVE"), we are also developing ZORYVE cream for the treatment of atopic dermatitis. In atopic dermatitis, we have successfully completed three pivotal Phase 3 clinical trials: INTEGUMENT-1 and -2 enrolled subjects 6 years of age or older and INTEGUMENT-PED enrolled subjects between the ages of 2 and 5 years. We are also conducting INTEGUMENT-OLE, an open label extension study of the long-term safety of ZORYVE cream 0.15% in individuals 6 years of age or older and roflumilast cream 0.05% in subjects between the ages 2 and 5 years. In the fourth quarter of 2022, we announced positive topline data from both INTEGUMENT-1 and -2 in atopic dermatitis, and in September 2023 we announced positive topline data from INTEGUMENT-PED and positive interim results from INTEGUMENT-OLE. In September 2023, we submitted a supplemental new drug application (“sNDA”) for ZORYVE cream 0.15% for the treatment of mild to moderate atopic dermatitis in individuals 6 years of age or older, which was accepted by the FDA and assigned a Prescription Drug User Fee Act ("PDUFA") target action date of July 7, 2024. Based on the positive results from the INTEGUMENT-PED study in September 2023, we expect to submit a subsequent sNDA for topical ZORYVE cream 0.05% for children ages 2 to 5 years of age if our current sNDA for ZORYVE cream 0.15% is approved for the treatment of mild to moderate atopic dermatitis in individuals 6 years of age or older.
Beyond seborrheic dermatitis, we are also developing ZORYVE foam for scalp and body psoriasis and have successfully completed our pivotal Phase 3 clinical trial. We announced positive topline data in September 2022, and we plan to submit an sNDA in the second half of 2024.
Beyond ZORYVE, we are developing ARQ-255, a deep-penetrating topical formulation of ivarmacitinib, a potent and highly selective topical Janus kinase type 1 ("JAK1") inhibitor, designed to preferentially deliver the drug deep into the hair follicle, the site of inflammation in alopecia areata, in order to potentially develop the first topical treatment for this disease. In December 2022, we announced that the first subject had been enrolled in a Phase 1b study evaluating ARQ-255 for the treatment of alopecia areata. The first subject in the alopecia areata cohort enrolled in the second quarter of 2023.
In September 2022, we acquired Ducentis BioTherapeutics LTD ("Ducentis") and its lead asset, DS-234 (now ARQ-234), a fusion protein that is a potent and highly selective checkpoint agonist of the CD200 Receptor (CD200R). Currently in the preclinical stage, we plan to develop ARQ-234 in atopic dermatitis, where we believe it could be a potentially highly complementary biologic treatment option to ZORYVE cream in that indication, if approved. ARQ-234 could potentially be used to treat other inflammatory conditions as well.
We have incurred net losses in each year since inception, including net losses of $262.1 million, $311.5 million and $206.4 million for the years ended December 31, 2023, 2022 and 2021, respectively. As of December 31, 2023, we had an accumulated deficit of $981.9 million and cash, cash equivalents, restricted cash and marketable securities of $272.8 million. As of December 31, 2023, we had $200.0 million outstanding under the Loan Agreement.
We expect to continue to incur losses and significant expenses as we commercialize ZORYVE cream in psoriasis and ZORYVE foam in seborrheic dermatitis, and as we advance our product candidates and label extensions through clinical trials, regulatory submissions, and commercialization. We expect to incur significant and prioritized commercialization expenses related to the sales, marketing, manufacturing, and distribution of ZORYVE cream and foam, while we focus our clinical development spend on ARQ-234, ARQ-255, and ZORYVE label extensions, if we obtain regulatory approval for them. If our available cash and marketable securities balances, amounts available under the Loan Agreement, and anticipated future cash flows from operations are insufficient to cover these expenses, we may need to fund our operations through equity or debt financings or other sources, such as future potential collaboration agreements. Adequate funding may not be available to us on acceptable terms, or at all. Any failure to obtain sufficient funds on acceptable terms as and when needed could have a material adverse effect on our business, results of operations, and financial condition. See “Liquidity, Capital Resources, and Requirements” below and Note 1 to the consolidated financial statements for additional information.
96
Table of Contents
Index to Financial Statements
We rely on third parties in the conduct of our nonclinical studies and clinical trials and for manufacturing and supply of our product candidates. We have no internal manufacturing capabilities, and we will continue to rely on third parties, many of whom are single source suppliers, for our nonclinical and clinical trial materials, as well as the commercial supply of our products.
Components of Our Results of Operations
Revenue
Product Revenue, Net
In August 2022, in conjunction with the launch of our first FDA approved product, ZORYVE cream, we began to recognize revenue from product sales, net of rebates, chargebacks, discounts, and other adjustments. We will continue to evaluate trends related to revenue for ZORYVE. Additionally, if our development efforts for our other product candidates and ZORYVE label extensions are successful and result in regulatory approval, we may generate additional revenue in the future from product sales.
Other Revenue
Other revenue relates primarily to the Huadong Agreement. See Note 6 to the consolidated financial statements for additional information.
Cost of Sales
Cost of sales includes direct and indirect costs related to the manufacturing and distribution of ZORYVE cream, including raw materials, third-party manufacturing costs, packaging services, and freight-in, as well as third-party royalties payable on our net product sales and amortization of intangible assets associated with ZORYVE.
Our cost of sales will reflect a lower average per unit cost of materials until inventory that was previously expensed is sold, which is expected to occur over the next two years. As of December 31, 2023 and December 31, 2022, the value of this inventory, mostly at the raw materials stage, was approximately $8.7 million and $14.1 million, respectively.
Operating Expenses
Research and Development Expenses
Since our inception, we have focused significant resources on our research and development activities, including conducting nonclinical studies and clinical trials, manufacturing development efforts, and activities related to regulatory filings for our product candidates. Research and development costs are expensed as incurred. These costs include direct program expenses, which are payments made to third parties that specifically relate to our research and development, such as payments to clinical research organizations, clinical investigators, manufacturing of clinical material, nonclinical testing, and consultants. In addition, employee costs, including salaries, payroll taxes, benefits, stock-based compensation, and travel for employees contributing to research and development activities are classified as research and development costs. We allocate direct external costs on a program specific basis (topical roflumilast program, topical JAK inhibitor program, and early-stage programs). Our internal costs are primarily related to personnel or professional services and apply across programs, and thus are not allocable on a program specific basis.
We expect to continue to incur research and development expenses in the future as we develop our product candidates. In particular, we expect to incur research and development expenses for the pediatric and open label extension Phase 3 trials of ZORYVE cream for atopic dermatitis, phase 1 ARQ-255 study for alopecia areata, and early development of ARQ-234 for atopic dermatitis.
97
Table of Contents
Index to Financial Statements
We have entered, and may continue to enter, into license agreements to access and utilize certain molecules for the treatment of dermatological diseases and disorders. We evaluate if the license agreement is an acquisition of an asset or a business. To date, none of our license agreements have been considered to be an acquisition of a business. For asset acquisitions, the upfront payments, as well as any future milestone payments made before product approval, are immediately recognized as research and development expense when due, provided there is no alternative future use of the rights in other research and development projects.
The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing, or costs required to complete the remaining development of ZORYVE cream, ZORYVE foam, ARQ-255, and ARQ-234 or any other product candidates. This is due to the numerous risks and uncertainties associated with the development of product candidates. See “Risk Factors” for a discussion of the risks and uncertainties associated with the development of our product candidates.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of salaries and related costs, including payroll taxes, benefits, stock-based compensation, and travel, and costs related to sales and marketing of ZORYVE cream. Other selling, general and administrative expenses include legal costs of pursuing patent protection of our intellectual property, insurance, and professional services fees for auditing, tax, and general legal services. We expect our selling, general and administrative expenses to continue to increase in the future as we continue to commercialize ZORYVE and potentially other product candidates, and support our operations, including increased expenses related to legal, accounting, insurance, regulatory, and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, directors and officers liability insurance premiums, and investor relations activities.
Other Income, Net
Other income, net primarily consists of interest income earned on our cash, cash equivalents, and marketable securities.
Interest Expense
Interest expense is related to interest incurred on our long term debt.
Provision for Income Taxes
Provision for income taxes is primarily due to foreign withholding taxes on the up-front payment received in connection with the Huadong Agreement. See Note 6 and Note 11 to the consolidated financial statements for additional information.
98
Table of Contents
Index to Financial Statements
Results of Operations
Comparison of the Years Ended December 31, 2023 and 2022
The following table sets forth our results of operations for the periods indicated:
| Year Ended December 31, | Change | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | $ | % | |||||||||||
| (in thousands) | ||||||||||||||
| Revenues: | ||||||||||||||
| Product revenue, net | $ | 29,186 | $ | 3,686 | $ | 25,500 | 692 | % | ||||||
| Other revenue | 30,420 | — | $ | 30,420 | * | |||||||||
| Total revenues | 59,606 | 3,686 | 55,920 | 1517 | % | |||||||||
| Operating expenses: | ||||||||||||||
| Cost of sales | 4,987 | 754 | 4,233 | 561 | % | |||||||||
| Research and development | 110,575 | 182,435 | (71,860) | (39) | % | |||||||||
| Selling, general and administrative | 185,145 | 122,124 | 63,021 | 52 | % | |||||||||
| Total operating expenses | 300,707 | 305,313 | (4,606) | (2) | % | |||||||||
| Loss from operations | (241,101) | (301,627) | 60,526 | (20) | % | |||||||||
| Other income (expense): | ||||||||||||||
| Other income, net | 11,786 | 5,821 | 5,965 | 102 | % | |||||||||
| Interest expense | (29,712) | (15,652) | (14,060) | 90 | % | |||||||||
| Loss before income taxes | (259,027) | (311,458) | 52,431 | (17) | % | |||||||||
| Provision for income taxes | 3,113 | — | 3,113 | * | ||||||||||
| Net loss | $ | (262,140) | $ | (311,458) | $ | 49,318 | (16) | % |
______________
*Not applicable
Product revenue, net
We began recording U.S. product revenue in the third quarter of 2022 following the FDA approval and subsequent commercial launch of ZORYVE cream in August 2022, and Canada product revenue in the second quarter of 2023 following the Health Canada approval and subsequent commercial launch of ZORYVE cream in June 2023. Net product revenue increased by $25.5 million for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase in revenue was primarily driven by end customer demand.
Other revenue
Other revenue is a result of license revenues received in connection with the Huadong Agreement. See Note 6 to the consolidated financial statements for additional information.
Cost of Sales
Cost of sales increased by $4.2 million for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase was related primarily to additional ZORYVE cream product costs incurred. Prior to the date on which the initial regulatory approval was received, costs of raw materials were recorded as research and development expense. Therefore, cost of sales will reflect a lower average per unit cost until the related inventory is sold, which is expected to occur over the next two years.
99
Table of Contents
Index to Financial Statements
Research and Development Expenses
| Year Ended December 31, | Change | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | $ | % | |||||||||||
| (in thousands) | ||||||||||||||
| Direct external costs: | ||||||||||||||
| Topical roflumilast program | $ | 35,607 | $ | 83,030 | $ | (47,423) | (57) | % | ||||||
| Topical JAK inhibitor program | 3,334 | 4,461 | (1,127) | (25) | % | |||||||||
| Other early stage programs | 5,681 | 1,128 | 4,553 | 404 | % | |||||||||
| In-process research and development | — | 29,720 | (29,720) | (100) | % | |||||||||
| Indirect costs: | ||||||||||||||
| Compensation and personnel-related | 44,613 | 41,396 | 3,217 | 8 | % | |||||||||
| Other | 21,340 | 22,700 | (1,360) | (6) | % | |||||||||
| Total research and development expense | $ | 110,575 | $ | 182,435 | $ | (71,860) | (39) | % |
______________
*Not applicable
Research and development expenses decreased by $71.9 million, or 39%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. The decrease was primarily due the completion of Phase 3 studies of ZORYVE cream in atopic dermatitis and ZORYVE foam in seborrheic dermatitis and scalp and body psoriasis, as well as the IPR&D expense as a result of the acquisition of ARQ-234 from Ducentis in the third quarter of 2022. Additionally, manufacturing costs recorded as research and development expenses decreased as we began capitalizing such costs to inventory upon FDA approval of ZORYVE cream in July 2022.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $63.0 million, or 52%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase was primarily due to an increase in compensation and personnel related expenses of $29.4 million, an increase in sales and marketing expenses of $24.8 million and an increase in professional services of $5.6 million. These increases were primarily due to our commercialization efforts, including the hiring of our full sales force for ZORYVE cream.
Other Income, Net
Other income, net increased by $6.0 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to the impact of higher interest rates, partially offset by a lower marketable securities balance.
Interest Expense
Interest expense increased by $14.1 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, due to an increase in our average long-term debt balance and the impact of higher interest rates. See Note 8 to the consolidated financial statements for additional information.
Provision for Income Taxes
Income tax expense of $3.1 million for the year ended December 31, 2023 was primarily due to foreign withholding taxes on the up-front payment received in connection with the Huadong Agreement. See Note 6 and Note 11 to the consolidated financial statements for additional information.
Comparison of the Years Ended December 31, 2022 and 2021
For a discussion of the year ended December 31, 2022 compared to the year ended December 31,
2021, please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2022.
Liquidity, Capital Resources and Requirements
Our primary sources of capital have been private placements of preferred stock, our IPO completed in January 2020, our follow-on financings in October 2020, February 2021, August 2022, and October 2023, our Loan
100
Table of Contents
Index to Financial Statements
Agreement, our ATM, and revenue from the sale of ZORYVE cream. We have incurred operating losses since our inception and have an accumulated deficit as a result of ongoing efforts to develop and commercialize our products and product candidates, including conducting nonclinical and clinical trials and providing selling, general and administrative support for these operations. As of December 31, 2023 and 2022, we had cash, cash equivalents, restricted cash, and marketable securities of $272.8 million and $410.8 million, respectively, and an accumulated deficit of $981.9 million and $719.8 million, respectively. We maintain cash balances with financial institutions in excess of insured limits. In September 2023, we received an upfront net payment of $27.0 million related to the Huadong Agreement. See Note 6 to the consolidated financial statements for additional information. In October 2023, we completed a public offering of shares of our common stock and prefunded warrants to purchase shares of our common stock, and received net proceeds of $93.6 million. Additionally, in November 2023, we received $2.2 million net proceeds due to the underwriters exercising their option to purchase additional shares related to our public offering. In December 2023, we sold 1,250,000 shares under the ATM and received $3.1 million in net proceeds. See Note 1 to the consolidated financial statements for additional information. As of December 31, 2023, we had $200.0 million outstanding under the Loan Agreement.
On November 1, 2023, we entered into an amendment to the Loan Agreement with SLR. Pursuant to the amendment, the terms of the Loan Agreement were revised to, among others, (i) eliminate the undrawn tranche C term loan of up to $25.0 million, (ii) modify the financial covenant relating to minimum net product revenue, and (iii) include an additional minimum financing covenant. The minimum financing covenant requires that we raise $31 million by April 1, 2024. To date, we have raised $5.3 million and have not complied with the minimum financing covenant. If we do not comply with the covenant, the debt could be accelerated. We intend to raise additional capital through (a) the sale or issuance of equity interests, (b) business development or collaboration agreements (including upfront, milestone, royalty and other payments), or (c) subordinated debt, in each case as permitted pursuant to the terms of the Loan Agreement. However, as our ability to raise any such additional capital is based in part on factors that are outside of our control, we cannot provide any assurance that we will be successful in raising such additional capital. This uncertainty as to our ability to comply with the minimum financing covenant indicate that we may be unable to continue as a going concern. Our financial statements do not include adjustments that might result from the outcome of this uncertainty.
We believe that our existing capital resources will be sufficient to meet the projected operating requirements for at least 12 months from the date of issuance of our financial statements, so long as the debt is not accelerated.
If our capital resources are insufficient to satisfy our requirements, we may need to fund our operations through the sale of our equity securities, accessing or incurring additional debt, entering into licensing or collaboration agreements with partners, grants, or other sources of financing. There can be no assurance that sufficient funds will be available to us at all or on attractive terms when needed from these sources. If we are unable to obtain additional funding from these or other sources when needed it may be necessary to significantly reduce our current rate of spending through, among other things, reductions in staff and delaying, scaling back, or stopping certain research and development programs, nonclinical studies, clinical trials or other development activities, and commercialization efforts. Insufficient liquidity may also require us to relinquish rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. In addition, market conditions impacting financial institutions could impact our ability to access some or all of our cash, cash equivalents and marketable securities, and we may be unable to obtain alternative funding when and as needed on acceptable terms, if at all.
We have based our projected operating requirements on assumptions that may prove to be incorrect and we may use all our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development, and commercialization of pharmaceutical products, we are unable to estimate the exact amount of our operating capital requirements. Any future funding requirements will depend on many factors, including, but not limited to:
•the timing, receipt, and amount of sales of any current and future products;
•the scope, progress, results, and costs of researching and developing our lead product candidates or any future product candidates, and conducting nonclinical studies and clinical trials, in particular our planned or ongoing development activities of ZORYVE cream in plaque psoriasis and atopic dermatitis, ZORYVE foam in seborrheic dermatitis and scalp psoriasis, ARQ-255 in alopecia areata, and our formulation and nonclinical efforts for ARQ-234;
•suspensions or delays in the enrollment or changes to the number of subjects we decide to enroll in our ongoing clinical trials;
101
Table of Contents
Index to Financial Statements
•the number and scope of clinical programs we decide to pursue, and the number and characteristics of any product candidates we develop or acquire;
•the timing of, and the costs involved in, obtaining regulatory approvals for any future product candidates;
•the number and characteristics of any additional product candidates we develop or acquire;
•the cost of manufacturing ZORYVE or any future product candidates and any products we successfully commercialize, including costs associated with building out our supply chain;
•the cost of commercialization activities for ZORYVE or any future product candidates are approved for sale, including marketing, sales and distribution costs, and any discounts or rebates to obtain access;
•our ability to establish and maintain strategic collaborations, licensing or other arrangements and the financial terms of any such agreements that we may enter into;
•the costs related to milestone payments to AstraZeneca, Hengrui, or any future collaborator or licensing partner, upon the achievement of predetermined milestones;
•any product liability or other lawsuits related to our products;
•the expenses needed to attract and retain skilled personnel;
•the costs involved in preparing, filing, prosecuting, maintaining, defending, and enforcing our intellectual property portfolio; and
•costs associated with any adverse market conditions or other macroeconomic factors.
Indebtedness
On December 22, 2021, we entered into a loan and security agreement, or Loan Agreement, with SLR and the lenders party thereto. The Loan Agreement was amended and restated on January 10, 2023 to include Arcutis Canada, Inc. as a borrower and party to the Loan Agreement. The lenders agreed to extend term loans to us in an aggregate principal amount of up to $225.0 million, comprised of: (i) a tranche A term loan of $75.0 million, (ii) a tranche B-1 term loan of $50.0 million, (iii) a tranche B-2 term loan of up to $75.0 million, available in minimum increments of $15.0 million, and (iv) a tranche C term loan of up to $25.0 million. We refer to the tranche A, tranche B, and tranche C term loans together as our Term Loans. As security for the obligations under the Loan Agreement, we granted SLR, for the benefit of the lenders, a continuing security interest in substantially all of our assets, including our intellectual property, subject to certain exceptions.
On November 1, 2023, we entered into an amendment to the Loan Agreement. Pursuant to the amendment, the terms of the Loan Agreement were revised to, among others, (i) eliminate the undrawn tranche C term loan of up to $25.0 million, (ii) modify the financial covenant relating to minimum net product revenue and remove the market capitalization threshold, and (iii) include an additional minimum financing covenant. The modified financial covenant requires us to generate a minimum net product revenue equal to 75% of our projected net product revenue as set forth in our annual plan for the respective period, tested on a trailing 12 month basis for the month ending December 31, 2023 and then tested on a trailing six month basis, as of the end of each month, for the month ending January 31, 2024 and each month thereafter. Pursuant to the amendment, each annual plan shall be approved by our board of directors and SLR, in its capacity as collateral agent, in its reasonable discretion. Any failure by us to deliver such annual plan on or before December 15 of the prior year shall be an immediate event of default. In addition, we agreed to raise at least $31.0 million in net cash proceeds, during the period commencing on November 1, 2023 and ending on April 1, 2024, from (a) the sale or issuance of the our equity interests, (b) business development or collaboration agreements (including upfront, milestone, royalty and other payments), or (c) subordinated debt, in each case as permitted pursuant to the terms of the Loan Agreement. Any failure by us to raise such net cash proceeds during the specified period shall be an immediate event of default.
The tranche A term loan was funded on December 22, 2021. Following the approval of ZORYVE cream, we drew down $125.0 million on the tranche B term loans, which we received in August 2022. As amended, the Loan Agreement provides for term loans to us in an aggregate principal amount of up to $200.0 million, which amounts were fully drawn as of December 31, 2023.
Principal amounts outstanding under the Term Loans will accrue interest at a floating rate equal to the applicable rate in effect from time to time, as determined by SLR on the third business day prior to the funding date of the applicable Term Loan and on the first business day of the month prior to each payment date of each Term
102
Table of Contents
Index to Financial Statements
Loan. The applicable rate is a per annum interest rate equal to 7.45% plus the greater of (a) 0.10% and (b) the per annum rate published by the Intercontinental Exchange Benchmark Administration Ltd. (or on any successor or substitute published rate) for a term of one month, subject to a replacement with an alternate benchmark rate and spread in certain circumstances. Starting in July 2023, the Secured Overnight Financing Rate (SOFR) for a term of one month was substituted for the benchmark rate. On December 31, 2023, the rate was 12.90%.
Interest payments are payable monthly following the funding of any Term Loan. Any principal amounts outstanding under the Term Loans, if not repaid sooner, are due and payable on January 1, 2027, or the Maturity Date. We may voluntarily prepay principal amounts outstanding under the Term Loans in minimum increments of $5.0 million, subject to a prepayment premium of (i) 3.0% of the principal amount of such Term Loan so prepaid prior to December 22, 2022, (ii) 2.0% of the principal amount of such Term Loan so prepaid after December 22, 2022 and prior to December 22, 2023, or (iii) 1.0% of the principal amount of such Term Loan so prepaid after December 22, 2023 and prior to December 22, 2025.
The Loan Agreement contains customary representations and warranties and customary affirmative and negative covenants, including, among others, requirements as to financial reporting and insurance and restrictions on our ability to dispose of its business or property, to change its line of business, to liquidate or dissolve, to enter into any change in control transaction, to merge or consolidate with any other entity or to acquire all or substantially all the capital stock or property of another entity, to incur additional indebtedness, to incur liens on its property, to pay any dividends or other distributions on capital stock other than dividends payable solely in capital stock or to redeem capital stock. We also agreed to a financial covenant whereby, beginning with the month ending December 31, 2023, we must generate net product revenue in excess of specified amounts for applicable measuring periods pursuant to the Loan Agreement.
If the Term Loans are accelerated due to, among others, the occurrence of a bankruptcy or insolvency event, we are required to make certain mandatory prepayments, including fees applicable by reason of such prepayment.
In addition, the Loan Agreement contains customary events of default that entitle the lenders to cause any indebtedness under the Loan Agreement to become immediately due and payable, and to exercise remedies against us and the collateral securing the Term Loans. Upon the occurrence and for the duration of an event of default, an additional default interest rate, or the Default Rate, equal to 4.0% per annum will apply to all obligations owed under the Loan Agreement.
In connection with the Loan Agreement, we are obligated to pay (i) a final fee equal to 6.95% of the aggregate original principal amount of the Term Loans funded upon the earliest to occur of the Maturity Date, the acceleration of any Term Loan and the prepayment, refinancing, substitution or replacement of any Term Loan and (ii) a certain amount of lenders’ expenses incurred in connection with the execution of the Loan Agreement. Additionally, in connection with the Loan Agreement, we entered into an Exit Fee Agreement, whereby we agreed to pay an exit fee in the amount of 3.0% of each Term Loan funded upon (i) any change of control transaction or (ii) a revenue milestone, calculated on a trailing six month basis. Notwithstanding the prepayment or termination of the Term Loan, the exit fee will expire 10 years from the date of the Loan Agreement.
We were in compliance with all covenants under the Loan Agreement as of December 31, 2023.
Cash Flows
The following table sets forth our cash flows for the periods indicated:
| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2021 | ||||||||
| (in thousands) | ||||||||||
| Cash used in operating activities | $ | (247,057) | $ | (257,715) | $ | (174,627) | ||||
| Cash provided by (used in) investing activities | 180,232 | (87,199) | (75,953) | |||||||
| Cash provided by financing activities | 101,323 | 301,798 | 281,947 | |||||||
| Effect of exchange rate changes on cash | (50) | — | — | |||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 34,448 | $ | (43,116) | $ | 31,367 |
Net Cash Used in Operating Activities
103
Table of Contents
Index to Financial Statements
During the year ended December 31, 2023, net cash used in operating activities was $247.1 million, which consisted of a net loss of $262.1 million and a change in net operating assets and liabilities of $23.5 million, partially offset by net non-cash and other charges of $38.6 million. The change in net operating assets and liabilities was primarily due to an increase in accounts receivable of $17.3 million, an increase in prepaid expenses and other current assets of $8.6 million, and an increase in inventories of $5.6 million, offset by an increase in accounts payable and accrued liabilities of $8.7 million. The net non-cash and other charges were primarily related to stock-based compensation expense of $38.8 million.
During the year ended December 31, 2022, net cash used in operating activities was $257.7 million, which consisted of a net loss of $311.5 million and a change in net operating assets and liabilities of $10.2 million, partially offset by net non-cash and other charges of $63.9 million. The change in net operating assets and liabilities was primarily due to an increase in accounts receivable of $8.5 million and an increase in inventories of $7.5 million, partially offset by a decrease of prepaid expenses and other current assets of $3.5 million. The net non-cash and other charges were primarily related to stock-based compensation expense of $32.7 million and acquired in-process research and development of $29.6 million.
During the year ended December 31, 2021, net cash used in operating activities was $174.6 million, which consisted of a net loss of $206.4 million, partially offset by net non-cash charges of $28.1 million and a change in net operating assets and liabilities of $3.6 million. The net non-cash charges were primarily related to stock-based compensation expense of $23.9 million. The change in net operating assets and liabilities was primarily due to an increase of $10.7 million in accounts payable and accrued liabilities due to an increase in bonus and clinical accruals, partially offset by an increase of $7.3 million in prepaid expenses and other current assets.
Net Cash Provided by (Used in) Investing Activities
During the year ended December 31, 2023, net cash provided by investing activities was $180.2 million, which was comprised primarily of the proceeds from the maturities of marketable securities of $406.5 million, partially offset by purchases of marketable securities of $225.8 million.
During the year ended December 31, 2022, net cash used in investing activities was $87.2 million, which was comprised primarily of purchases of marketable securities of $415.4 million, cash paid for IPR&D related to the acquisition of Ducentis of $15.5 million and a milestone payment made to AstraZeneca of $7.5 million, partially offset by the proceeds from the maturities of marketable securities of $351.5 million.
During the year ended December 31, 2021, net cash used in investing activities was $76.0 million, which was comprised primarily of purchases of marketable securities of $292.5 million, partially offset by the proceeds from the maturities of marketable securities of $217.6 million.
Net Cash Provided by Financing Activities
During the year ended December 31, 2023, net cash provided by financing activities was $101.3 million, which was comprised primarily of the net cash proceeds received from our October 2023 public stock offering of $95.8 million and our December 2023 sale of stock under our ATM facility of $3.1 million.
During the year ended December 31, 2022, net cash provided by financing activities was $301.8 million, which was comprised primarily of the net cash proceeds received from our August 2022 public stock offering of $161.6 million, our August 2022 debt facility draw down of $125.0 million, and our March 2022 sale of stock under our ATM facility of $14.5 million.
During the year ended December 31, 2021, net cash provided by financing activities was $281.9 million, which was comprised primarily of the net cash proceeds received from the follow-on financing in February 2021 of $207.5 million as well as from our debt financing in December 2021 of $72.4 million.
104
Table of Contents
Index to Financial Statements
Contractual Obligations and Contingent Liabilities
The following summarizes our significant contractual obligations as of December 31, 2023:
Facility Operating Lease
In April 2020, we amended our lease agreement for our facility in Westlake Village, California to relocate to a new expanded space including 22,643 square feet. The lease payment term for the new space began on December 30, 2020 and will terminate 91 months thereafter, with a renewal option term of five years. We have a one-time option to cancel the lease after month 67.
The lease is subject to fixed rate escalation increases with an initial base rent of $76,000 per month and includes rent free periods aggregating approximately one year. The amended lease agreement required that we deliver a letter of credit to the landlord of $1.5 million upon occupying the space, which is allowed to be reduced throughout the lease period as rent obligations are met. Accordingly, as of December 31, 2023, we have a letter of credit and related restricted cash account of $0.9 million. The total commitment under the operating lease agreement is $4.8 million, including $1.0 million for each of the years 2024 and 2025, $1.1 million for each of the years 2026 and 2027, and $0.6 million for the year 2028. See Note 7 to the consolidated financial statements for additional information.
Long-Term Debt Obligations
As of December 31, 2023, we had $200.0 million outstanding under our Loan Agreement. See Notes 1 and 8 to the consolidated financial statements for additional information. The undiscounted future payments of principal and interest under the Loan Agreement as of December 31, 2023 is $292.4 million, including $26.3 million for the year 2024, $26.1 million for each of the years 2025 and 2026, and $213.9 million for the year 2027.
License Agreements & Acquisition
The terms of certain of our license agreements and our acquisition of Ducentis require us to pay potential future milestone payments based on product development and commercial success. The amount and timing of such obligations are unknown or uncertain. These potential obligations are further described in Note 6 to the consolidated financial statements.
Manufacturing Agreements
We have entered into manufacturing supply agreements for the commercial supply of ZORYVE, which include certain minimum purchase commitments. Firm future purchase commitments under these agreements are approximately $1.9 million for 2024, and approximately $0.8 million per year for 2025 and 2026. This amount does not represent all of our anticipated purchases, but instead represents only the contractually obligated minimum purchases or firm commitments of non-cancelable minimum amounts.
Indemnification
In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.
In accordance with our certificate of incorporation and bylaws, we have indemnification obligations to our officers and directors for specified events or occurrences, subject to some limits, while they are serving at our request in such capacities. There have been no claims to date, and we have director and officer insurance that may enable us to recover a portion of any amounts paid for future potential claims.
105
Table of Contents
Index to Financial Statements
Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules.
Critical Accounting Policies and Use of Estimates
Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these consolidated 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 the consolidated financial statements, as well as the reported expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. 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 judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.
While our significant accounting policies are more fully described in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements and understanding and evaluating our reported financial results.
Nonclinical and Clinical Accruals and Costs
We record accrued liabilities for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of nonclinical studies, clinical studies, clinical trials and contract manufacturing activities. These costs are a significant component of our research and development expenses. Research and development costs are expensed as incurred unless there is an alternative future use in other research and development projects. We accrue for these costs based on factors such as estimates of the work completed and in accordance with agreements established with third-party service providers under the service agreements. As it relates to clinical trials, the financial terms of these contracts are subject to negotiations which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided under such contracts. Payments made prior to the receipt of goods or services to be used in research and development are capitalized until the goods or services are received. Such payments are evaluated for current or long-term classification based on when they will be realized. Additionally, if expectations change such that we do not expect goods to be delivered or services to be rendered, such prepayments are charged to expense. Our objective is to reflect the appropriate expense in our consolidated financial statements by matching those expenses with the period in which the services and efforts are expended. We account for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial utilizing financial models taking into consideration discussions with applicable personnel and outside service providers. In this manner, our clinical trial accrual is dependent in part upon the timely and accurate reporting of progress and efforts incurred from CROs, contract manufacturers and other third-party vendors. Although we expect our estimates to be materially consistent with actual amounts incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in our reporting changes in estimates in any particular period. We make significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, we adjust our accrued liabilities. We have not experienced any material differences between accrued costs as of December 31, 2023 and 2022 and actual costs incurred.
106
Table of Contents
Index to Financial Statements
Revenues
Pursuant to Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), we recognize revenue when a customer obtains control of promised goods or services. We record the amount of revenue that reflects the consideration that we expect to receive in exchange for those goods or services. We apply the following five-step model in order to determine this amount: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) we satisfy each performance obligation.
We only apply the five-step model to contracts when it is probable that it will collect the consideration to which we are entitled in exchange for the goods or services that we transfer to the customer. Once a contract is determined to be within the scope of ASC 606 at contract inception, we review the contract to determine which performance obligations we must deliver and which of these performance obligations are distinct. We recognize as revenue the amount of the transaction price that is allocated to each performance obligation when that performance obligation is satisfied or as it is satisfied.
Product Revenue, Net
We sell our product to our Customers in the United States and Canada. Our Customers subsequently resell the products to pharmacies, health care providers, and patients. In accordance with ASC 606, we recognize net product revenues from sales when the Customers obtain control of our products, which typically occurs upon delivery to the Customer. Our payment terms are generally between 30 - 65 days.
Revenues from product sales are recorded at the net sales price, or “transaction price,” which includes estimates of variable consideration that result from (a) invoice discounts for prompt payment and distribution service fees, (b) government and private payer rebates, chargebacks, discounts and fees, (c) product returns and (d) costs of co-pay assistance programs for patients, as well as other incentives. Reserves are established for the estimates of variable consideration based on the amounts earned or to be claimed on the related sales. The reserves are classified as reductions to trade receivables, net if payable to a Customer or accrued liabilities if payable to a third-party. Where appropriate, we utilize the expected value method to determine the appropriate amount for estimates of variable consideration based on factors such as our historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. The amount of variable consideration that is included in the transaction price may be constrained and is included in net product revenues only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts of consideration ultimately received may differ from our estimates. If actual results vary from our estimates, we adjust these estimates, which would affect net product revenue and earnings in the period such variances become known.
Distribution Service Fees: We engage with wholesalers to distribute our products to end customers. We pay the wholesalers a fee for services such as: data reporting, inventory management, chargeback administration, and service level commitment. We estimate the amount of distribution services fees to be paid to the Customers and adjust the transaction price with the amount of such estimate at the time of sale to the Customer.
Prompt Pay Discounts: We provide our Customers with a percentage discount on their invoice if the Customers pay within the agreed upon timeframe. We estimate the probability of Customers paying promptly based on the percentage of discount outlined in the agreement, and deduct the full amount of these discounts from its gross product revenues and accounts receivable at the time such revenues are recognized.
107
Table of Contents
Index to Financial Statements
Product Returns: We provide Customers a return credit in the amount of the purchase price paid by Customers for all products returned in accordance with our returned goods policy. In the initial sales period, we estimate our provision for sales returns based on industry data and adjust the transaction price with such estimate at the time of sale to the Customer. Once sufficient history has been collected for product returns, we will utilize that history to inform our returns estimate. Once the product is returned, it is destroyed. We do not record a right-of-return asset.
Chargeback: A chargeback is the difference between the manufacturer's invoice price to the wholesaler and the wholesaler’s customer's contract price. The wholesaler tracks these sales and "charges back" the manufacturer for the difference between the negotiated prices paid between the wholesaler's customers and wholesaler's acquisition cost. We estimate the percentage of goods sold that are eligible for chargeback and adjust the transaction price for such discount at the time of sale to the Customer.
Co-payment Assistance: Patients who meet certain eligibility requirements may receive co-payment assistance. We recognize contra-revenue expense, and adjusts the transaction price for, co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators.
Rebates and Discounts: We accrue rebates for contractually agreed-upon discounts with commercial insurance companies and mandated discounts under government programs such as the Medicaid Drug Rebate Program in the United States. Our estimates for expected utilization of commercial insurance rebates are based on data received from our customers. Our estimates for rebates under government programs are based on statutory discount rates and expected utilization as well as historical data we have accumulated since product launch. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters’ unpaid rebates. If actual rebates vary from estimates, we may need to adjust accruals, which would affect revenue in the period of adjustment.
Stock-Based Compensation
We account for share-based payments at fair value. For share-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date for such awards is the date of grant and the expense is recognized on a straight-line basis, over the expected vesting period. For share-based awards that vest subject to a performance condition, we recognize compensation cost for awards if and when we conclude that it is probable that the awards with a performance condition will be achieved on an accelerated attribution method. We account for forfeitures as they occur.
We calculate the fair value measurement of stock options using the Black-Scholes option pricing model and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgement.
Fair value of common stock— The fair value per share of our common stock for purposes of determining stock-based compensation will be the closing price of our common stock as reported on the applicable grant date.
Expected Term—The expected term represents the period that we expect our stock-based awards to be outstanding. We used the simplified method (based on the mid-point between the vesting date and the end of the contractual term) to determine the expected term.
Expected Volatility—Prior to 2022, we did not yet have sufficient trading history for our common stock to use it solely for our historical volatility, the expected volatility was estimated based a combination of our own historical common stock volatility as well as the average historical volatilities for comparable publicly traded pharmaceutical companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their similar size, stage in the life cycle and area of specialty. We applied that process until a sufficient amount of historical information regarding the volatility of our stock price became available. Beginning in 2022, having over two years of trading history, we began using solely our own historical stock price for expected volatility.
Risk-Free Interest Rate—The risk-free interest rate is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of option.
Dividend Yield—We have never paid dividends on common stock and have no plans to pay dividends on our common stock. Therefore, we used an expected dividend yield of zero.
108
Table of Contents
Index to Financial Statements
See Note 10 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information concerning certain of the specific assumptions we used in applying the Black-Scholes option pricing model to determine the estimated fair value of our stock options. Certain of such assumptions involve inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation could be materially different.
Income Taxes
As of December 31, 2023, we had net deferred tax assets of $216.2 million. The deferred tax assets have been offset by a valuation allowance due to uncertainties surrounding our ability to realize these tax benefits. The deferred tax assets are primarily composed of NOL tax carryforwards. As of December 31, 2023, we had federal and state NOL carryforwards of $676.0 million and $523.3 million, respectively, available to potentially offset future taxable income. In addition, we had foreign NOL carry forwards of approximately $4.0 million as of December 31, 2023, which can be carried forward indefinitely. As of December 31, 2023, we also had federal and California research and development tax credit carryforwards of approximately $19.8 million and $4.4 million, respectively, available to potentially offset future federal income taxes. The federal research and development tax carryforwards, if not utilized, will expire beginning in 2037. The California research and development tax credit carryforwards are available indefinitely. Federal and California tax law impose significant restrictions on the utilization of NOL carryforwards in the event of a change in ownership, as defined by Internal Revenue Code Section 382 and 383. We believe the Company has had one or more such ownership changes in the past, and we may have additional ownership changes in the future. These ownership changes could limit our ability to use all the Company's NOL carryforwards, credit carryforwards, or other tax attributes.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements.